text:
    Twin City Tile & Marble Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8730.
    Promulgated May 4, 1927.
    Amounts paid stockholding officers and employees determined to be distributions of profits and not compensation for services.

      O. R. Fletcher, Esq., for the petitioner.

      D. D. Shepard, Esq., for the respondent.

      This is a proceeding for the redetermination of deficiencies in income and profits taxes for the years 1919, 1920, and 1921 in the amounts of $1,238.81, $11,770.03, and $18,251.88, respectively. The portions of the deficiencies in controversy arise from the disallowance by the Commissioner in each year of certain amounts deducted by petitioner as salaries of officers and employees who were also stockholders.
    FINDINGS OF FACT.
    In May, 1910, Frank Armstrong, Arne Verio, and James Taylor associated themselves as a partnership under the name of the Twin City Tile & Marble Co., with its place of business at Minneapolis, Minn. Between May, 1910, and March, 1911, F. O. Streed, E. W. Streed, and II. B. Watson became members of the partnership. The business of the partnership consisted of procuring and performing contracts for the installation of tile and marble.
    From time to time after the partnership was organized the various members contributed to its capital in varying amounts. The capital contributed by each member up to and including December 31, 1910, was as follows:
    James Taylor-$1, 697.86
    Arne Verio_ 1,162. 49
    Frank Armstrong_ 816. 30
    F. O. Streed_ 1,114.98
    H. B. Watson__ 3S6.48
    In March, 1911 the petitioner was incorporated under the laws of Minnesota, and took over the business of the partnership. The corporation had its principal office in Minneapolis and has continued to procure and perform contracts for the installation of tile and marble work in residences and in public and other buildings where such work is required.
    The original authorized capital stock of the corporation was $30,000, par value common stock and $20,000 par value 7 per cent preferred stock. In 1917 the authorized capital stock was increased from $50,000 to $100,000, divided into $70,000 par value common stock and $30,000, 7 per cent preferred stock. All of the stock was divided into shares having a par value of $100 each.
    The members of the partnership became stockholders in the petitioner corporation and immediately after its organization stock was issued. The holdings of the various stockholders were increased so that the number of shares held by them was as follows on the dates indicated:

    In 1917 T. G. Hidding, who formerly had been connected with the Alberene Stone Co., acquired stock in the petitioner corporation and subsequent to August 1, 1917, and throughout the years involved in this proceeding was a stockholder and an officer.
    H. B. Watson severed his connection with the company in 1919, selling his common stock to the other stockholders and retaining his preferred stock until July 26, 1921.
    Until 1915 the greater part of the business of the corporation was buying and installing tile. In 1915 petitioner purchased two marble-milling machines and began to do some of its own cutting and polishing of marble. In 1920 additional marble-milling machinery was installed.
    The folloAving statement shows for the years 1911 to 1921 the petitioner’s net sales, amounts claimed by petitioner as salary paid officers and stockholding employees and profits, salaries of officers and employees having been considered in determining the profits:

    The folloAving is a statement of the amounts paid by the petitioner corporation during the years 1911 through 1921 to its officers and such employees Avho were stockholders which it claimed to be compensation for sendees rendered:

    The petitioner in its returns for 1919, 1920, and 1921 deducted for compensation paid its officers and such employees as owned its stock the amounts shown below, whereas in an audit of the returns the respondent allowed only a portion of the amounts deducted. The following is a statement of the position held by each stockholder, the amounts deducted by the petitioner as compensation and the amounts allowed and disallowed by the respondent:

    The following resolutions were adopted by the directors of the petitioner corporation at meetings held on the dates indicated:

      August 1J¡, 1918. Motion made by Hidding and seconded by Watson that owing to high cost of living that all common stockholders have monthly salary increased equal to 9% per annum of common stock held by them to be divided into monthly payments dated back to .January 1st, 1918.

      May IS, 1920. Motion made by Taylor and seconded by Armstrong that due to continued increase in wages among working mechanics, common stockholders interested in corporation salaries be increased 8% per cent dating from January 1st, 1920.

      September 6, 1920. Motion made by Taylor and seconded by Armstrong that a salary bonus be paid from August 1st, 1920 to December 31st, 1920, paid monthly as follows to:
    F. O. Streed_$484.00
    James Taylor_ 548. 00
    Arne Verio_ 400.00
    F. Armstrong- 400. 00
    E. W. Streed_ 424.00
    F. A. Streed_ 65.00
    T. G. Hidding. 340. 00

      November 11¡, 1921. •salary bonus be given Motion made by Hidding and seconded by Taylor that a
    James Taylor.. _$4932.00
    F. O. Streed_ _ 4356.00
    F. Armstrong— _ 3600.00
    A. Verio_ _ 3600.00
    E. W. Streed— _ 3816.00
    Art Streed-_ 576.00
    Hidding_ _ 4320.00
    The above increases and bonuses were in direct proportion to the holdings of stock of the parties named.
    F. O. Streed was president of the company. In 1919 he was 59 years of age and had been engaged in the tile and marble business since 1885. Prior to his connection with the partnership, he had been connected with other companies in Minneapolis, engaged in the tile and marble business, and from 1892 to 1910 was president of the Northwestern Tile & Marble Co. of Minneapolis. From 1910 to 1919 his duties were to secure contracts for marble and tile, figure with Taylor on prices to submit on such work, help look after the financial matters of the company, including the borrowing of money and the endorsement of all notes at the bank. Beginning with 1919, Plidding took over part of the duties theretofore performed by F. O. Streed and thereafter Streed’s activities consisted chiefly of figuring on bids and visiting and interviewing architects and contractors in connection with tile and marble work. He had a large acquaintance among the architects and contractors throughout the region and this assisted him in obtaining contracts. He continued to endorse all paper of the petitioner at the banks. Not considering contracts of $1,000 or less, Streed was instrumental in obtaining for the petitioner contracts as follows:

      During 1919, 1920, and 1921 Streed devoted his entire time to the business of the petitioner, putting in extra time in the evenings.
    In 1919 James Taylor, who was vice president of the petitioner corporation, was about 45 years of age and had been working in the tile and marble business since 1890.
    Prior to coming to the partnership in 1910 he had worked with several tile and marble companies located in St. Paul, Minneapolis, and Milwaukee. At the time he became associated in the partnership with Verio and Armstrong the parties agreed that he should do the office work, make estimates for the purpose of submitting bids for work, send out materials, and supervise all of the work from the office. The foregoing have continued to be the general nature of his work with the petitioner. He prepared and assisted in preparing estimates for bids to be submitted by the petitioner and assisted Hidding in purchasing all materials. One of his duties was to see that the necessary labor was employed to fulfill the contracts.
    Since 1911, he has been a member of the arbitration board for adjusting disputes between employers and employees engaged in tile and marble work. This gave him such an acquaintance with the labor situation as enabled him at all times to keep the petitioner supplied with the necessary labor. During the years involved in this proceeding Taylor devoted his entire time to the business, putting in a great deal of overtime. He endorsed all paper of the petitioner for loans at the -various banks and at times his liability thereon was as high as $40,000. In addition to his other services, he was instrumental in procuring contracts for the petitioner totaling $17,030.85 in 1919, $47,696 in 1920, and $3,260 in 1921, not including contracts of less than $1,000.
    T. G. Hidding was secretary-treasurer. For about ten years prior to 1917, he was connected with the Alberene Stone Co. of New York, which was a quarrier and producer of soapstone. About six years of the time that he was employed by that company, he was engaged in selling its products to jobbers and marble mills, and installing them in laboratories of universities and other institutions of learning. These duties took him over a large number of the States. When he became connected with petitioner corporation about August 1, 1917, he brought to the business the agency for the products of the Alberene Stone Co., and since has continued to act as its agent. This connection has been profitable to the petitioner. During the years 1917 and 1918 Hidding’s duties consisted of keeping-petitioner’s books, supervising the sale of the products of the Al-berene Stone Co. and acquainting himself with the tile and marble business. During 1919 he became secretary of the petitioner corporation, and his duties then consisted of estimating for tile and marble work, securing contracts, keeping the books, assisting Taylor in purchasing materials, looking after the finances of the company and with F. O. Streed and Taylor endorsing all the paper of the company at the banks. At times his liability on such paper was as high as $40,000. Not considering contracts of $1,000 or less, Hidding was instrumental in obtaining for the petitioner contracts as follows:

    During the years 1919, 1920, and 1921 he devoted his entire time to the business of the petitioner. During 1920 and 1921 he put in extra time, doing practically all of the bookkeeping for the company after office hours and taking no vacations in those years. Petitioner procured between 35 per cent and 40 per cent of the contracts upon which Taylor, F. O. Streed and Hidding figured.
    Frank Armstrong was 44 years of age in 1919. Prior to joining the partnership in 1901 he had had ten years’ experience in the tile and marble business. His duties with the petitioner have been acting as superintendent of construction. His work-in that capacity consisted of the supervision of work being installed, checking all material as it arrived on the job, seeing that the proper material was delivered to the men and that it was properly installed according to the specifications. He reported to Taylor as general superintendent, but was responsible for the successful completion of the particular job he was supervising. Pie made weekly reports of the progress of the work and kept and reported the time of the men working under him, who at times numbered as high as thirty. On the larger jobs his entire time was engaged in performing his duties as superintendent, whereas on the smaller jobs he spent about half of his time in working with the men. On some of the larger jobs Verio assisted in supervision of construction, being in charge of the tile work, while Armstrong was in charge of the marblework. All work installed was supervised by either Armstrong, Verio, or E. W. Streed. During 1919, 1920, and 1921 Armstrong supervised alone construction of work totaling $146,082.65, and in association with Verio totaling $35,605, not including contracts amounting to less than $1,000. Armstrong during these years devoted his entire time to the business, as well as putting in overtime.
    Verio in 1919 was 35 years of age and prior to becoming a member of the partnership in 1910 was employed in the tile and marble business. His duties with the petitioner were similar to those of Armstrong and at times he had as many as sixty men. working under his supervision. During 1919, 1920, and 1921 he supervised alone the construction of work totaling $171,325.60, and in association with E. W. Streed totaling $16,500, not considering any contracts amounting to less than $1,000. He devoted his entire time to the business, putting in much overtime.
    E. W. Streed was about 45 years of age in 1919 and prior to coming into the partnership in 1910 had been engaged in the tile and marble business. He is a brother of F. O. Streed, the president of the petitioner corporation. His duties with the petitioner were simi-' lar to those of Armstrong and Verio, except that his work was more particularly connected with residences and smaller jobs. During 1919, 1920, and 1921, he supervised alone the construction of’ work totaling $22,343.85, not considering contracts amounting to less than $1,000. He devoted his entire time to the business.
    F. A. Streed was about 30 years of age in 1919, and is the son of F. O. Streed. He has been employed by the petitioner since 1911. His principal work was that of draftsman, in the course of which he drew up from the general plans the plans and specifications for the marble and tile work for submission to architects and contractors, and also got out schedules of the various sizes of all the material that went into the various jobs. He had an assistant in- this work. He did some estimating and also procured some contracts. He devoted his entire time to the business.
    During 1919, 1920, and 1921 the petitioner did work in North Dakota, South Dakota, Wisconsin, Illinois, and Iowa, as well as in Minnesota.
   OPINION.

Thammell :

The respondent has disallowed as deductions in computing the net income of the petitioner for the years 1919, 1920, and 1921 the amounts of $5,631, $26,140.36, and $37,582.74, respectively, being portions of the amounts deducted as salaries for officers and employees who were stockholders of the petitioner corporation. The disallowance is based on the ground that the amounts disallowed were not in fact reasonable compensation for personal services actually rendered but constituted distributions of profits.

Section 234 (a) (1) of the Revenue Acts of 1918 and 1921 provides that in computing the net income of corporations subject to tax there shall be allowed as a deduction “ 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 * *

The petitioner does not deny that the increase and bonuses paid to its officers and stock-owning employees were in direct proportion to their stock ownership, but contends that the amounts authorized and paid were reasonable for the services rendered when the ability, experience, responsibility, duties, and services of such officers and employees and their worth to the business is considered.

The amounts paid to the officers and stockholding employees and deducted as compensation for the years involved bear approximately the following percentages to the amounts paid, for 191?:

F. O. Streed.. Taylor.. Bidding.. Armstrong--. Verio_ E. W. Streed. F. A. Streed.. 1919. 1920. 1921. Per cent. 147 162 145 156 154 144 123 Per cent. 325 395 337 393 370 356 200 Per cent. 408 500 507 483 465 460

The first question to determine is whether the amounts which were disallowed by the respondent as compensation to officers and stockholding employees were paid by the corporation as compensation for services rendered. If the amounts were in fact distributions of profits as determined by the respondent, they would not be allowed as deductions in determining the petitioner’s net income. It may be that if the amounts had been paid as compensation, they would have been allowed as being reasonable. In determining whether the amounts were compensation for services or. were distributions of profits, all the facts and circumstances must be considered and not merely the fact that the amounts were reasonable.

In this case, we find that the amounts which the petitioner claimed as additional compensation for services rendered were paid to the stockholders of the corporation in the exact proportion to their stock-holdings. The payments of the amounts were authorized by resolutions of August 14,1918, May 18,1920, September 6,1920, and November 14, 1921. The resolution of August 14,1918, authorized a monthly salary increase to the stockholders equal to 9 per. cent of the common stock held by them dated back to January 1,1918. The resolution of May 18, 1920, was substantially the same except that the increase was to be based on 8% per cent of the stock ownership on January 1, 1920. The other resolutions, while not prescribing that the increase shall be based specifically on stock ownership, actually used that as a basis in determining the amounts to be paid. In other words, the amount of stock owned by each stockholder seems to have been the sole criterion or- measure of the additional amounts to be paid him. The increases allowed were not based on the amount of compensation which each officer was receiving at the time.

The value of services of an individual is not dependent upon the amount of stock owned. The value of services and the amount of stock owned have no necessary relationship to each other. The meas-, ure used in determining the increases in this case was stock ownership, regardless of the fact that certain stockholders may have been entitled to a greater or lesser amount if the value of their services were solely considered. In order to be compensation for services, the value of the services must measure the amount and not stock ownership. Conceding for the sake of argument that the services of individuals in this case were fairly worth the amounts they received, this fact alone is not sufficient to constitute the amounts compensation. They must have been intended and paid as such.

In the Appeal of Woodcliff Silk Mills, 1 B. T. A. 715, we said:

The fact that salaries paid to its officers by a corporation are in direct proportion to the stockholdings of the respective officers is strong evidence of an intent to distribute profits as salaries and must be overcome by clear evidence showing that the salaries are reasonable in amount and actually represent compensation for personal services rendered.

We are of the opinion after a consideration of all of the evidence that the petitioner has not shown that the amounts which were disallowed by the respondent were in fact compensation for services rendered and not distributions of profits.

Judgment will Toe entered on 15 days’ notice, u/nder Rule 50.


source: Caselaw Access Project

author: Littleton:

license: Public Domain

text:
    Richmond Hosiery Mills, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 7763, 3703.
    Promulgated May 4, 1927.
    1. The Board is unable from the evidence in this proceeding to determine what portion, if any, of amounts expended for advertising should be regarded as capital expenditures.
    2. Contributions to an organization having for its purpose the gathering of statistics on imports and in keeping manufacturers advised of the tariff legislation, and to an organization having for its purpose the prevention of labor troubles were proper deductions from gross income as ordinary and necessary business expenses.

      Sam E. 'Whitaker, Esq., for the petitioner.

      George G. Witter, Esq., for the respondent.
    The Commissioner determined deficiencies in income and profits taxes in the amounts of $15,666.60 for 1918, $28,598.86 for 1919, and $4,370 for 1920. The petitioner in both cases assigned several errors, but by stipulations and withdrawals only two questions are now in dispute: (1) Whether the petitioner may include in its invested capital an aggregate amount of $223,749.77 alleged to have been expended during the years 1908 to 1914, inclusive, in an intensive advertising campaign to advertise a particular brand of hosiery under the trade-mark “ Wimdeghose ” and charged at the time to current expense; (2) whether contributions made during the taxable years to the American Protective Tariff League and The League of Industrial Rights, of both of which petitioner is a member, are deductible from gross income.
    It has been stipulated that (1) these two proceedings be consolidated for hearing and decision; (2) the Commissioner’s determination with respect to the deduction of the commissions paid by petitioner on the sale of its preferred stock was correct; (3) the Commissioner correctly reduced invested capital for the years in q'uestion by the prorated amount of income and profits taxes shown to be due on returns filed for said years and by the amount of additional taxes for said years found to be due; (4) on January 1, 1914, the property of the petitioner had sustained a total depreciation of $125,716.88; (5) that in computing invested capital for the years in question the date of January 1, 1914, shall be taken as the starting point, and to reflect depreciation accrued to that date the above sum shall be deducted from the gross value of the taxpayer’s depreciable property on that date as found by the Commissioner, and to reflect depreciation thereafter accruing the rates established by the Commissioner shall be applied.
    FINDINGS OF FACT.
    The petitioner is a Georgia corporation organized in 1898 with principal office and place of business in Rossville. A portion of its business designated as the Chattanooga Knitting Mills is located at Chattanooga, Tenn. Prior to 1909 the Chattanooga Knitting Mills was operated under the name of Mathis-Davis Co. but has been a part of the Richmond Hosiery Mills’ business since 1904. It is engaged in the manufacture and sale of hosiery.
    From the date of organization until 1908 petitioner sold its goods without a trade name. In 1907, the Dry Goods Economist, a trade publication, proposed to it the adoption of a trade-mark “ Wunder-hose ” and that an advertising campaign be carried on over a period of time in order to permanently establish with the public its good will and trade mark “Wunderhose.” In 1908 the trade-mark “ Wunderhose ” was copyrighted and in the latter part of that year an intensive advertising campaign in the Dry Goods Economist and other trade journals was commenced, and continued until the early part of 1914, in the prosecution of which petitioner expended a total amount of $223,749.77, or approximately $35,000 a year. The amount paid or incurred in each of the years was charged to expensé. During the six years succeeding this advertising campaign an average of about $2,500 a year was spent for general advertising purposes. In the inauguration of this advertising campaign, the petitioner did so for the purpose and with the belief and conviction that by so doing it would thereby establish a permanent good will asset in its business.
    The adoption of the trade-mark “ Wunderhose ” for a part of its hosiery business and the advertising campaign were parts of the same plan. The trade-mark “ Wunderhose ” portrayed a box containing four pairs of hose and the figure $1. Upon the adoption and registration of the trade-mark it was decided that goods sold under it should be advertised as the goods of the Chattanooga Knitting Mills, a trade name given to that portion of the petitioner’s business. The plan was that the petitioner’s salesmen should carry two lines of goods, one of the Chattanooga Knitting Mills, covered by the trademark “ Wunderhose ” and the other of the Richmond Hosiery Mills, which at that time had no trade-mark or trade brand. Prior to the time of the adoption of the trade-mark “ Wunderhose ” there was no such name in existence, nor was there any concern known to the trade as the Chattanooga Knitting Mills. Upon the adoption of the trade-mark “ Wunderhose ” sale of this merchandise was segregated on the books of the petitioner from all other sales.
    In 1912 the petitioner adopted another trade brand known as “Arrowhead ” which was designated as Richmond Hosiery Mills sales account. It also exported goods under a number of foreign trade-marks. The “Wunderhose” sales do not include any goods exported.
    The gross sales of hosiery during the advertising campaign ending in 1914 were as follows:

    The gross sales of hosiery from 1915 to 1920, inclusive, were as follows:

      The invested capital, net earnings, and the percentage of earnings to capital from 1908 to 1914, inclusive, after deducting amounts spent for advertising during this period, and the invested capital, net earnings, and percentage of earnings to capital for the period 1915 to 1920 follow:

    The invested capital, net earnings, and the percentage of earnings to capital from 1908 to 1914, inclusive, after capitalizing the amount spent for advertising “ Wunderhose ” and the invested capital, net earnings, and the percentage of earnings to capital for the period 1915 to 1920, inclusive, subsequent to the advertising campaign, are as follows:

    The charging of expenditures for advertising to expense was in line with the consistent business policy adopted in the early days of the company to reduce the fixed assets of the company as nearly as possible to the sum of one dollar.

      During tlie taxable years 1919 and 1920, petitioner was a member of the Amercan Protective Tariff League, an organization of manufacturers having for its purpose the gathering of statistics on the importation of hosiery and other merchandise, the keeping of corporations advised as to tariff legislation and the obtaining from corporations information as to what they consider to be to their advantage in this regard. During 1919 and 1920, petitioner made contributions to this organization in the amounts of $150 and $100, respectively. In 1919 petitioner contributed $100 to an association of manufacturers of which it was a member known as The League of Industrial Eights, organized to forward and promote the interests of manufacturers through prevention of labor disputes. The petitioner alleges that $25 contributed toward the securing of a Brigade Post at Chattanooga Park, near Eossville, Ga., should be deducted as a necessary business expense, but during the trial this question was waived by the petitioner.
   OPINION.

Littleton:

Several questions were raised by the petition but all except two were withdrawn or stipulated. It is stipulated that the Commissioner’s determination with respect to the deduction of the commissions paid by petitioner on the sale of its preferred stock, and the Commissioner’s determination with respect to the reduction of invested capital for the years in question by the prorated amount of income and profits tax shown to be due on returns filed for said years and by the amount of additional tax for said years found to be due by the Commissioner was correct. In accordance with stipulation filed, the depreciation agreed upon, the value of property, and the rates established by the Commissioner with respect thereto are approved.

The two remaining questions are: (1) Whether the petitioner may include in invested capital for the years 1918, 1919, and 1920, the amount of $223,'749.11 expended during the years 1908 to 1914, inclusive, for development of the trade-mark “Wunderhose”; (2) whether contributions made by the petitioner during the taxable years in question to the American Protective Tariff League and The League of Industrial Eights, of both of which petitioner was a member, were proper deductions from gross income as ordinary and necessary expense.

The petitioner was during the taxable years, and still is, engaged in the manufacture and sale of hosiery. Prior to 1908 it sold to jobbers and had no trade-mark or trade names. In 1908 it adopted the trade-mark “Wunderhose” and decided upon an intensivé advertising campaign to cover a period from the end of 1908 until during the year 1914, involving the expenditure of approximately $35,000 a year to establish the trade-mark “Wunderhose,” and to build up a market for its product.

Approximately $35,000 a year was spent in advertising “ Wunder-hose ” during this campaign. After the year 1914, when the campaign closed, only about $2,500 a year was spent for general advertising purposes. The sales of “ Wunderhose ” increased from about $115,000 in the first year of the inauguration of the advertising campaign to more than $354,000 during the campaign, and to $1,527,-289.52 in 1920, the last taxable year in question.

It is evident that the amount of $223,749.77 for advertising purposes during the years 1908 to 1914, inclusive, was out of all proportion to the petitioner’s business at that time, and is evidence of the fact, as was testified to by all of the officers of the corporation and others who were in a position to know, that it had in view the establishment of a- permanent asset rather than merely increasing current business.

The Commissioner, while admitting that large sums were expended for advertising purposes, contends that the expenditures made were not of a capital nature but were ordinary and necessary expenses for the respective years, and as such amounts were charged to expense on the books of the petitioner it should not be permitted to restore the amounts to invested capital. The Commissioner further contends that even though a portion of the amount expended in this advertising campaign could be regarded as a.capital expenditure, the petitioner has never made any segregation of the amount which could be properly termed a capital expenditure and the amount that represented a current expense item, and that the resulting capital asset, if any, did not have the value claimed during the taxable years.

The amount of money spent for expansion and promotion of its business by advertising the “ Wunderhose ” is not in dispute. The only question is whether the amount so spent was properly chargeable to current expense or whether at this time petitioner should be permitted to restore to capital the expenditures previously recorded on the books as current expense.

That an erroneous recordation of an expenditure is no bar to its ultimate restoration to its proper status for income and profits-tax purposes has been stated by the Board on several occasions. Appeal of Gilliam Mfg. Co., 1 B. T. A. 967; Appeal of Union Metal Mfg. Co., 1 B. T. A. 395; and Appeal of Goodell-Pratt Co., 3 B. T. A. 30.

In each of the above-cited appeals, the fact that the expenditures were of a capital nature was not in dispute, whereas in this proceeding the main question at issue is whether the expenditures were of such a definite capital nature that they may be restored to, and considered a part of, petitioner’s invested capital for the years on appeal. Expenditures made in prior years and charged to expense will not be restored to capital in the absence of satisfactory evidence that the amount sought to be restored was specifically expended in the acquisition of an asset of a permanent nature. Appeal of Cramer-Krasselt Co., 3 B. T. A. 388; Appeal of Northwestern Yeast Co., 5 B. T. A, 232.

The petitioner argues with much plausibility that the expenditures in question resulted in the acquisition of an asset from which benefits ran to it through the succeeding years after the advertising campaign ceased and that therefore the entire amount should be considered a capital expenditure. It appears that after the expenditures ceased “ Wunderhose ” continued to be sold even in greater volume than before and we are asked to say, along a line of -syllogistic reasoning, that therefore an asset of-a permanent nature was acquired with the payment of $223,749.77 therefor, which should be capitalized.

The first difficulty arises from an inability to make a satisfactory segregation as between capital and expense of the entire amounts expended. It is evident that the petitioner was looking more to future, than present, sales when the advertising campaign was authorized and carried out, but it is likewise apparent that a substantial part of the amount in question produced immediate, rather than prospective, benefits. The public has a short memory concerning such matters as we are -here dealing with. Because of this fact, established concerns continue their advertising campaigns in order to keep constantly before the people the -product which they are manufacturing, as well as to prevent the usurpation of its place in the minds of the purchasing public by a similar article. The-petitioner’s product was of an inexpensive and short-lived nature and, therefore, the users of 1914 would not in all probability be the users in succeeding years without continued advertising, unless the character of the hose became so impressed on their minds that they would continue to ask for the same trade brand. The petitioner answers this argument by showing that its sales of “ Wunderhose ” not only continued after the advertising campaign closed, but also increased in the succeeding years. As to this we can not overlook the fact that the years- following 1914 were abnormal- years when other factors may have caused the continued sales in this line of goods and that the sales of the other products of the petitioner’s plant showed a corresponding increase, without extended advertising. It should be noted, also that traveling salesmen wore constantly engaged in securing orders for “ Wunderhose ” in the same manner as -they did for petitioner’s other products. •

As we have heretofore said in this opinion, the manner in which the petitioner treated its expenditures for advertising on its books is not conclusive of their nature. This is particularly true of the years prior to the incidence of the income and profits-tax laws, but when we note that in 1925 the petitioner made an expenditure of $110,000, more than three times the average amount expended in the years from 1908 to 1914, and principally in advertising another brand of hosiery, and claims this as a deduction from gross income in its income-tax returns for that year, it is apparent that the petitioner is recognizing that sales for that year are attributable at least in part to current advertising. Although we are not passing on the correctness of the expenditure in 1925, we do consider that the policy of the company in 1925 and other years of charging advertising to expense is an evidentiary fact which may properly be considered in determining whether the expense in question is to be treated as capital or expense. It evidences a recognition that results from advertising a product of the character in question are in a measure immediate and are, therefore, more properly chargeable as an expense of the year when expended than as producing an asset the value of which will remain with, and be productive of income to, the company in the succeeding years.

The Board is satisfied that the advertising campaign carried on from 1908 to 1914 had for its major purpose the establishing of the trade-mark “ Wunderhose ” in such a way in the minds of the public purchasing this grade of hose that benefits to the petitioner would flow therefrom beyond the year when the expenditures were made, but we are not convinced that the entire amount was a capital expenditure when made nor are we satisfied that it resulted in the acquisition of an asset which was yet in existence to the extent claimed in the years on appeal. It may be that in such cases as this upon a proper showing, some portion of the total amount expended for advertising could be capitalized, but when we look to all of the facts and circumstances disclosed by the record in this proceeding any attempt to make an allocation as between expense and capital would be a mere guess unsupported by any sound reason. The action of the Commissioner in eliminating this item from invested capital must, therefore, be sustained.

The second question involved is whether the contributions made to the American Protective Tariff League and The League of Industrial Eights are proper deductions from gross income as ordinary and necessary business expenses.

The primary object of the American Protective Tariff League was to gather statistics concerning imports and to keep manufacturers advised concerning tariff legislation and obtain information from manufacturers as to what they considered to be for their best interest in that regard. We think the contributions for such purposes come within the term of ordinary and necessary expense of carrying on a trade or business and that the Commissioner erred in denying the deduction of such contribution from gross income. The contribution to The League of Industrial Eights, an organization having for its purpose the prevention of labor troubles, was an expenditure directly connected with the business and was of such a character as properly to be considered an ordinary and necessary expense incident to the carrying on of a business. It should be allowed as a deduction from gross income. Appeal of California Brewing Assn., 5 B. T. A. 347.

Judgment will be entered on 16 days’ notice, under Rule 60.

Murdock concurs in the result only.


author: MoRRis:

text:
    Public Opinion Publishing Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4474.
    Promulgated May 6, 1927.
    Commissioner’s determination as to capital expenditures approved.

      Harry Harper, O. P. A., for the petitioner.
    A. JS. Faulkner, Esq., for the respondent.
    This proceeding is for the redetermination of deficiencies in income and profits taxes of $6,022.15 for 1920, and $1,705.06 for 1921. The issue raised is whether certain expenditures made during the respective years should be capitalized or deducted as ordinary business expenses.
    FINDINGS OF FACT.
    The petitioner, a South Dakota corporation located at Watertown, was organized approximately 19 years ago. It is engaged in job printing and publishing a daily newspaper. The capital stock of the corporation was and is $25,000.
    Prior to 1920 the Non-Partisan League established a newspaper in Watertown, which was at the time supporting the daily published by the petitioner. Watertown has a population of about 10,000. The subscription campaign carried on by the newspaper cut down the circulation of the petitioner. To offset the losses sustained the petitioner held subscription campaigns in 1920 and 1921.
    The petitioner’s subscription list before the first campaign numbered approximately 5,200 subscribers. The campaign was conducted by a professional campaign manager and field men. Premiums were offered and subscriptions solicited for periods from six months to three years. Most of the subscribers took the paper for a period of one year. All subscriptions were paid in advance. The cost of the 1920 campaign was $15,839.64. At the conclusion of the campaign the petitioner’s subscription list had increased to 5,500. The 1921 campaign inaugurated late in 1920 cost the petitioner $11,592.59. It increased the circulation list to 7,200 subscribers. The expenditures made in 1920 and 1921 on the subscription campaigns covered money paid for the subscription contest manager, the people employed, general expenses in-the'way of getting subscribers and the premiums offered.
    The petitioner did not place a value on its subscription lists, but the 1920 amended return carried them as an asset valued at $25,000. Another time an auditor of the petitioner’s books carried the subscription lists at a value of $20,000 in certain -statements which he prepared.
    The amounts expended for ihe campaign in 1920 and 1921 were taken as deductions from gross income in the respective years by the petitioner. The respondent disallowed the deductions, capitalized the expenditures, and determined the asserted deficiencies.
   OPINION.

MoRRis:

There is no doubt that the circulation structure of ' a newspaper is a capital asset, Appeal of Danville Press, Inc., 1 B. T. A. 1171; Appeal of Gardner Printing Co., 4 B. T. A. 37. It is likewise well settled that the circulation structure of a daily newspaper is an intangible asset. Appeal of Herald-Despatah Co., 4 B. T. A. 1096. When such an asset is purchased, the amount expended therefor is a capital expenditure. Appeal of Gardner Printing Co., supra; Appeal of Pevely Dairy Co., 1 B. T. A. 385; Appeal of Goodell-Pratt Co., 3 B. T. A. 30.

The specific question presented by this proceeding is whether when such an asset is developed, by the corporation itself and the cost thereof charged to expense, such cost is a capital expenditure. The facts show that the purpose of the two campaigns was not only to maintain the number of subscribers, but to increase it. To the extent ¡that the expenditures maintained the number of subscribers, they may be ordinary and necessary expenses, but we are unable to determine the amount allocable thereto. The Commissioner held that they were capital expenditures, and we can not determine from the record that he erred in that regard.

Judgment will be entered for the respondent.


text:
    News Publishing Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8078.
    Promulgated May 6, 1927.
    1. Where a corporation secures an amendment to its charter by means oí which its authorized capital stock is increased, issues this stock for stock of a like par value of a corporation which held its stock, liquidates the latter corporation, and cancels its own stock which the latter held, there is not thereby anything paid in to the corporation.
    2. Under the foregoing'conditions, stock of another'corporation not affiliated, which was taken over by the corporation should he valued at the cash value at date, of liquidation.
    3. Amounts paid to build up circulation structure and amounts expended in the acquisition and manufacture of lithographing plates which are used from year to year, both of which amounts were originally charged to expense,' may not be restored to invested capital, unless definite information as to the expenditures is shown.
    4. Affiliation denied in the absence of evidence as to the control exercised by the company claiming affiliation. -
    5. Under section 234 of the Revenue Act of 1918, there is no provision for' the partial writing down of an account prior to the time when the debt is ascertained to be worthless, or for charging off a partial loss on account of an investment in a corporation prior to the time the actual loss is determined.

      Harvey D. Jacob, Esq., and Waiter A. Bolinger, Esq., for the petitioner.

      P. J. Bose, Esq., for the respondent.
    This proceeding is for the redetermination of deficiencies of $11,114.62 and $8,072.29 for the calendar years 1918 and 1919, respectively.
    The errors assigned by the petitioner are: (1) The failure of the Commissioner to allow certain proved tangible and intangible assets as invested capital; (2) the failure of the Commissioner to permit petitioner to file consolidated returns for itself and its subsidiary, the Washington News Co., of Washington, Pa.; (3) the failure of the Commissioner to allow as a deduction lor bad debts in the years on appeal advances made to the Washington Daily News of Washington, Pa. (This error is contended for only if the second error is not found.)
    FINDINGS OF FACT.
    The petitioner is a West Virginia corporation which was organized in 1890 with a capital stock of $14,000, and is engaged primarily in the publication of a daily afternoon and Sunday morning paper. This capitalization was increased from time to time by stock dividends and one sale of stock to employees for $5,000 cash so that its outstanding capital stock was $75,000 on January 16, 1904, when its total capital stock was acquired by the newly formed Wheeling Printing & Paper Co. (hereinafter sometimes referred to as the Holding Company) in exchange for $310,000 capital stock of the latter company.
    Another corporation which it is necessary to consider in connection with this appeal is the Intelligencer Publishing Co., (hereinafter referred to as the Intelligencer) a business begun prior to the Civil War and continued, either under individual or partnership form of organization, until 1893 when it was incorporated with a capital stock of $100,000, and had such an outstanding capital stock when 89 per cent of its capital stock was acquired by the Wheeling-Printing & Paper Co. in 1904. Its business was that of publishing a daily morning paper.
    In the negotiations leading up to the consolidation of the petitioner and the Intelligencer, considerable discussion took place as to the basis on which the consolidation would be effected. Finally, it was decided that the Holding Company would be formed with a capital stock of $400,000, $310,000 of which would be issued for the stock of the petitioner and $90,000 for the stock of the Intelligencer. On January 15, 1904, the day before the consolidation was to have become effective and after announcement to that effect had been made, a fire occurred in the plant of the petitioner resulting in a loss of approximately $75,000. The majority stockholder of the Intelligencer thereupon objected to the old basis of its entering the consolidation, but the agreement was ultimately effected as decided upon except that one stockholder of the Intelligencer, owning approximately $11,000 capita] stock, refused to enter the consolidation. The Holding Company held as its only assets $75,000 capital stock of the petitioner and $89,000 capital stock of the Intelligencer.
    The three corporations continued in existence until 1914, when, for reasons of economy in state taxation, the petitioner secured an amendment to its charter by which its authorized capital stock was increased from $75,000 to $400,000, and new stock issued to the old stockholders of the petitioner in exchange for the stock of the Holding Company of like par value. The Holding Company was thereupon dissolved and its assets, consisting of $89,000 par value of the .stock of the Intelligencer and $75,000 par value of stock of the ■petitioner, were taken over by the petitioner, the old stock of the petitioner being canceled.
    The petitioner and the Intelligencer were ruled nonaffiliated for the years on appeal.

      No exact evidence was given as to petitioner’s earnings from date of incorporation, though the business was successful. Dividends were paid for the greater part of the period from 1892 to 1904 at the rate of 6 per cent on the capitalization. The stock was closely held, no sales being made at or prior to 1904, except one sale of $5,000 to employees, three or four years prior to this date. In addition to the payment of dividends, earnings were left in the business to the extent that its net worth on January 1,1904 (including that represented by outstanding capital stock), was approximately $170,000. On account of a fire loss in 1904, no dividends were paid in 1904 and 1905, but dividend payments were resumed in 1906, in which year and in the following year dividends were paid on the outstanding capital stock of the Holding Company at the rate of 2 per cent. Subsequently, with the exception of one year, up to and including 1913, dividends were paid at the rate of 6 per cent on the capital stock of the Holding Company.
    Subsequent to the 1914 merger, the petitioner paid dividends at the rate of 6 per cent upon its total capitalization. In addition thereto, it paid one preferred-stock dividend of 50 per cent and one preferred-stock dividend of 20 per cent and has paid 7 per cent on these issues of stock.
    The net worth of the petitioner as shown by its books of account on January 1, 1904, was approximately $170,000. Due to a fire on January 15, 1904, which caused a loss of approximately $75,000, the net worth on January 16, 1904, the date of the consolidation, was substantially less than that on January 1, 1904. The next statement of its net worth was on December 31, 1905, when it was $149,321.10. At the end of subsequent years it was as follows:

    Various sums were spent by petitioner in building up circulation structure from 1892 to 1904 by means of popularity contests and other schemes common to the newspaper business, which amounts were charged to expenses. These expenditures from 1899 to 1916 were $76,139.20 for salaries and expenses of solicitors who were engaged solely in securing new business for the petitioner. Prior to 1904 various amounts had been expended in the acquisition and production of plates, many of which were used beyond the year in which acquired or manufactured in the lithographing and engraving business which was run as a branch of the newspaper. These expenditures were not capitalized, but charged to expense when made. Some of these plates had become obsolete by 1904.
    The Intelligencer paid dividends on its capital stock from 1898 to 1898. In 1899 the majority of its stock was sold. From 1899 to 1904, the operation of the business was not so successful though it did prove a fair competitor in publishing the Wheeling Intelligencer, a morning paper, to the petitioner which published the Wheeling News, an afternoon and Sunday morning paper. Subsequent to 1904 no dividends were ever paid by the Intelligencer, though its net worth increased $78,309.08 from December 31, 1905, to" January 1, 1914.
    In computing the invested capital of the petitioner for 1918 and 1919, the Commissioner allowed as invested capital the capital stock and surplus as reflected by its books at the time of the reorganization in 1904 plus such earnings as had accrued since that date, thus disallowing the difference between the par value of the Holding Company’s stock which was issued for petitioner’s stock in 1904 and the net book value of petitioner’s assets at that date. The Commissioner allowed no value for circulation structure or for plates, expenditures for both of which had been charged to expense.
    The pertinent facts as far as necessary to a consideration of errors (2) and (3) alleged are as follows:
    ' In 1913 or 1914, certain wealthy citizens of Washington, Pa., interested the petitioner in organizing the Washington News Co, (hereinafter referred to as the News), for the purpose of publishing a regular Republican newspaper in that town, the two papers published having joined the so-called Progressive Party, headed by the late Theodore Roosevelt. It was agreed that the corporation would be capitalized at $25,000, that the citizens would contribute $15,000 and the petitioner would contribute $10,000. The amount pledged by the petitioner was paid and stock issued therefor', but only approximately $11,000 was paid in by the citizens.
    The corporation began the publication of the News on April 1, 1914, and continued until 1920, when operations were suspended and the affairs of the corporation wound up.' The entire management of the corporation was carried on by the petitioner, and no further' contributions were made, or assistance given, by the citizens for the operation or management of the News. Print paper was furnished by the petitioner and advances were made to cover a part of the cost of operations, which advances on December 31, 1916, amounted to $16,349.97. Advances were made by the petitionbr until the News ceased operations.

      In 1917, the petitioner decided that its investment in the News, including not only its original investment, but also advances subsequently made, which it carried as an asset, was of doubtful value since the liabilities of the News far exceeded its assets, and began charging it off as a matter of good accounting practice. The amount charged off during 1918 was $8,685.61 and during 1919 was $16,-120.72. Both amounts were disallowed by the Commissioner as deductions from gross income for 1918 and 1919, though they were allowed upon final liquidation of the News.
    The Commissioner held that the petitioner and the News were not affiliated for the years on appeal.
    The only meeting of the stockholders was that held at the time of organization in 1914. The suspending of the operations and winding up of the affairs of the News in 1920 was handled entirely by the petitioner without any notice to Washington (Pennsylvania) stockholders.
   OPINION.

Littleton:

The first error alleged by the petitioner is that the Commissioner erred in failing to allow certain proven tangible and intangible assets as a part of invested capital, and in support thereof sets up these contentions:

(a) The petitioner is entitled to include in its invested capital for the taxable years in question the actual cash value of the tangible property (the tangible property being the total capital stock of the original issue of the News Publishing Co. and 89% of the capital stock of the Intelligencer Publishing Co.) acquired by the Wheeling Printing & Paper Co. in exchange for stock at the time of the latter’s incorporation in 1904.

(b) If the first point should be denied, then it must follow that the News Publishing Co. resulting from the reorganization in 1914 was in effect an entirely new entity and that therefore the petitioner is entitled to include in its invested capital for the taxable years in question the actual cash value of the tangible property acquired by it for the new stock at the time of the 1914 reorganization.

(c) Such amounts as had been expended in the building up of a circulation structure and in the acquisition and manufacture of plates should be considered as capital expenditures and the amounts thereof considered in determining invested capital.

In connection with this point the petitioner asks that it be allowed to include as a part of its invested capital the surplus earned from 1904 (if this date is taken as a starting point), or from 1914 (if the latter date is taken as the starting point) to the taxable years under consideration, but it is not felt that this point is in serious controversy as it is understood that in the invested capital as determined by the Commissioner, earned surplus as reflected by the petitioner’s books has been allowed.

Since the Wheeling Printing & Paper Co. was dissolved in 1914, it is not necessary for us to determine what might have been the invested capital of this consolidated group (Wheeling Printing & Paper Co. and the petitioner) had both of them remained in existence during the taxable years on appeal. Suffice it to say that they do not occupy such a status, and no assets were paid in to the petitioner in 1904. Therefore, the contentions advanced under subdivision (a) above Avill not be considered further.

This brings us to the alternative proposition advanced by the petitioner, viz., that in 1914, when the petitioner, by amendment to its charter, increased its capital stock from $75,000 to $400,000, issued new stock for the stock of the Wheeling Printing & Paper Co. of a like par value and then dissolved the latter company, circumstances arose which would justify a revaluation of assets as of this date for invested capital purposes under the provisions of the Revenue Act of 1918.

The Wheeling Printing & Paper Co. held as its only assets in 1914 the $75,000 capital stock of the petitioner and $89,000 capital stock of the Intelligencer Publishing Co. By amendment to its charter, petitioner increased its capital stock to $400,000 and exchanged new stock for stock of a like par value of the Holding Company and then dissolved the Holding Company, thereby acquiring whatever assets the Holding Company had. It will thus be seen that the assets acquired were the capital stock of the Intelligencer and its own old stock when new stock had already been issued under the amendment to its charter to take the place of the old stock.

The record is not sufficiently complete to determine all the legal incidents arising from the securing of the amendment to the charter of the petitioner, but accepting the evidence as offered we find that merely an amendment to an existing charter was secured. What, in general, the amendment to a charter means is stated in 14 Corpus Juris 197, where numerous cases are cited in support of this projio-sition:

The mere amendment of a charter or articles of incorporation does not create a new corporation or otherwise affect the identity of the corporation, or its existing rights of action, property rights, or liabilities; and this is true even where the amendment is made by the substitution of a new charter, if the manifest intention is to amend merely and not to create a new corporation.

That it was not the intention to create a new corporation is shown by the fact that the amendment was secured merely for economy in state taxation, to avoid paying tax on the capital stock of two corporations instead of one.

Therefore we are dealing with the same corporation which was organized in 1890, as far as its legal entity is concerned. Our question now is whether anything was paid in in 1914, at the time of the merger, in the sense contemplated by section 326, Revenue Act of 1918, for invested capital purposes.

When the petitioner issued its own stock for the stock of the Wheeling Printing & Paper Co. and then effected a liquidation of the latter company, it acquired the assets of the Wheeling Printing & Paper Co. by the payment of stock therefor. Appeal of Regal Shoe Co., 1 B. T. A. 896. But what were these assets ? The entire capital stock of the petitioner and $89,000 capital stock of the Intelligencer Publishing Co. As to the capital stock of the petitioner which was thus acquired, it can not be said that anything came into the corporation which was not already there. That the assets of a corporation are owned by the corporation and not by the stockholders is too well established to admit of questioning. The petitioner owned its assets before the merger and it likewise owned them afterwards. The only new asset which can be said to have been paid in at this time was the stock of the Intelligencer, and as to this the petitioner is entitled to have the cash value when paid in, viz., in 1914, under the provisions of section 326, Revenue Act of 1918.

The next question presented is the value of this stock, but no satisfactory evidence has been presented as a basis of determining its value. No sales were made, either of this stock or that of the Wheeling Printing & Paper Co., at or about the date in question. The same is true of the stock of the petitioner. When we examine the earnings of the Intelligencer prior to 1914, we find that they amounted to a total of $18,309.08 in the eight years immediately preceding 19.14, and that no dividends were paid during that period. What the net or gross value of its assets was during this period is not shown. The Commissioner allowed this stock in invested capital at its par value and this is as liberal as the Board can be on the basis of the evidence presented.

As a further contention with respect to invested capital, petitioner claims that the amounts which were expended in building up circulation structure and in the acquisition and manufacture of plates which were used in the business beyond the year when acquired or manufactured, should be considered as capital expenditures, even though originally charged to expense.

That circulation structure is perhaps the most important asset of a news publishing business was recognized by the Board in the Appeal of Gardner Printing Co., 4 B. T. A. 37, and, therefore, if its cost can be determined it must be considered in determining petitioner’s invested capital. Our difficulty lies in determining its cost. The only definite statement we have is that there was expended from 1899 to 1916, $76,139.20 as salaries and expenses of solicitors engaged in building up and maintaining circulation structure. We are of the opinion that this is not sufficient. See Public Opinion Publishing Co., 6 B. T. A. 1255. We said in the Gardner Printing Co. appeal, supra:

A newspaper circulation structure is an asset which must be continually-supported by such advertising and soliciting as will result in constantly bringing in new subscribers and new advertising patrons to take the place of those who, in the regular course of business, are constantly dropping off.

Any addition to invested capital on this account must, therefore, be denied.

The evidence is likewise insufficient to make a restoration to the capital account because of expenditures made in the acquisition and manufacture of plates. That the expenditure for an item which has a useful life of more than a year should generally be treated as a capital expenditure was recognized by the Board in the Appeal of Winifrede Coal Co., 1 B. T. A. 566; Appeal of Union Collieries Co., 3 B. T. A. 540; Appeal of Goodell-Pratt Co., 3 B. T. A. 30. But again we are without definite information as to the amount expended, when expended and the extent to which these plates are still in use and therefore no amounts which the petitioner may have invested in this way can be considered in determining its invested capital.

Petitioner claims that it should be affiliated with the Washington News Co. for the years on appeal under the provisions of section 240 (b), Kevenue Act of 1918, which reads as follows:

For tlie purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns directly or controls through closely affiliated interests or by a nominee or nominees substantially all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests.

It is under clause one above that the petitioner claims affiliation on the ground that entire control of the News was vested in it.

The record does not disclose the exact amount of stock issued, though it does show that of the authorized capital stock of $25,000, $10,000 capital stock was issued to the petitioner and that approximately $11,000 cash was paid in by citizens of Washington, Pennsylvania, but it was not definitely shown that stock was issued for the latter amount. The only contributor (of the citizens) who testified stated that $1,000 capital stock was issued for his contribution of a like .amount. The probabilities are, therefore, that the entire $11,000 was issued for capital stock.

That the entire operation and management of the News were left to the petitioner the record is clear, but the Board is not convinced that there was such “ control ” as is contemplated by the statute. As was-stated in the Appeal of Isse Koch & Co., 1 B. T. A. 624, “ control ” means actual control. In the same opinion it is stated further that, “ The control, however, must be shown to be a genuine and real control actually exercised, and it can not be established by mere assertions or agreements between majority and minority stockholders unsupported by facts.”

That the stockholders (other than the petitioner) did not at any time after the News began -operation exercise any control in the sense contemplated by the statute is -certainly shown, but that they did not have power- through the voting rights of their stock to exercise control is not shown. We are of the opinion that something-more must bo shown than a mere failure to exercise control which potentially, at least, existed.

In the Appeal of Watsontown Brick Co., 3 B. T. A. 85, we said:

Control of tlie business is not control of the stock of a corporation conducting a business, nor, where 'a minority of stockholders are present, even though quiescent, representing 27.04 per cent of the stock, can we hold that the stock owned or controlled by the parent company constitutes substantially all of such stock.

We denied affiliation in the Appeal of Goldstein Bros. Amusement Co., 3 B. T. A. 408, for the reason that control over the-minority stock was speculative and because ownership and control of 15 per cent of stock by same interests is insufficient to establish affiliation where there is no evidence of actual control of minority stock and it is merely shown that minority interests were quiescent and permitted majority to manage corporation.

The Board must, therefore, hold that the two corporations were not affiliated for the years on appeal.

Since it has been found that the petitioner and the News were not affiliated, it becomes necessary to consider the third error alleged in which the petitioner seeks to have allowed as deductions the amounts which it charged off in the years on appeal on account of advances to, and investment in, the News. The News continued in operation throughout the years on appeal, and, while the business was not profitable for those years, the petitioner continued to make advances to carry on its operation. The extent to which the amount charged off in each year represented aihounts charged off on account of advances and the extent to which on account of the original investment are no.t shown.

When the News was still in operation, and no definite ascertainment of the extent of the loss which may have been sustained had been made, Certainly there is no justification for saying that a loss on account of investment in its stock has been realized which can be recognized under the Eevenue Act of 1918. The investment in the stock gave the petitioner its proportionate right to a participation in the assets upon liquidation, and what the value of this right would be, would not be determined until liquidation.

As to the deduction claimed on account of a partial charge-off of the advances, there is no provision under the Revenue Act of 1918 for the partial writing down of an account. Steele Cotton Mill Co., 1 B. T. A. 299.

We must hold, therefore, that the action of the Commissioner was correct in disallowing the deductions claimed on account of losses due to investment in, and advances to, the Washington News Co. -

The deficiencies as determined by the Commissioner are, therefore, approved.

Judgment will be entered for the respondent.


author: Green:

text:
    Orrell Mills, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 5379, 13676.
    Promulgated May 10, 1927.

      Wilfred L. Hagerty, O. P. A., for the petitioner.

      J. W. Fisher, Esq., for the respondent.
   Green:

The above-entitled proceedings were by stipulation consolidated for hearing. In Docket No. 5819 the petitioner seeks a redetermination of its tax liability for the year 1918, for which the Commissioner determined a deficiency in income and profits taxes in the sum of $11,077.75. The errors alleged are:

Failure of the Commissioner of Internal Revenue to recognize, on the evidence submitted, claim for a paid-in surplus of $67,917.47 and additional depreciation thereon, arising- through the acquisition of tangible personal property in exchange for stock.
Disallowance by the Commissioner of Internal Revenue of $53,000.00 of the $05,000.00 claimed as a paid-in surplus arising through the acquisition of water rights.
Failure on the part of the Commissioner of Internal Revenue to properly compute depreciation on real estate and machinery, depreciation write-offs from 1907-1916, inclusive, not being considered in his calculations.

In Docket No. 13676 the petitioner seeks a redetermination of its tax liability for the year 1921, for which the Commissioner has determined a deficiency in income and profits taxes in the sum of $3,363.03. The errors alleged are:

Calculation of depreciation allowances by the Commissioner on the net reduced book value of properties instead of upon cost.
The failure of the Commissioner to consider correction of invested capital for paid-in surplus arising through acquisition for stock of properties with a value in excess of the par value of such stock.
Failure of the Commissioner in his examination to correct invested capital for the erroneous reduction thereof by the proration of 1920 income and excess-profits taxes.

FINDINGS OF FACT.

The petitioner is a corporation organized under the laws of the State of Rhode Island with its office and place of business in the town of Glendale. It is engaged in the manufacture of woolen goods in which it uses electrical energy derived from water power. The power site, canals, etc., are located adjacent to the power plant. There is installed a water wheel over which flows water from the canal, and from which the petitioner derives electrical energy equivalent to approximately 160 horse power. There is nothing in the record to indicate the ownership of the mill, the power site, or the power plant, nor is there any evidence of its cost or value.

In 1907 the petitioner had on its books three “ property accounts,” namely: “machinery account,” “buildings account,” and “tenements.” The accounts of the petitioner as regards depreciation were not kept in the regular way. The amounts charged off for depreciation were arbitrary amounts and were charged off irregularly, generally only in the years when there were profits. Each year when it was sought to charge off depreciation, the amount of such depreciation so arbitrarily computed, was deducted from the amount of each of said property accounts and the depreciation for the succeeding year computed upon. the remaining balance. This method of handling depreciation was continued until 1917 or 1918, after which time a reserve for depreciation was set up. At the time the change was made the depreciation previously written off was not restored to the various property accounts. .In 1918 and 1919 the depreciation was computed upon the appreciated value of plant facilities arrived at by an appraisement.

The foregoing are all of the material facts which can be found in the record.

Judgment will be entered for the respondent in both proceedings.


author: Littleton :

text:
    W. P. Davis, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9436.
    Promulgated May 10, 1927.
    A decline in the value of stock does not give rise to a deductible loss.

      J. G-. Sehurs, O. P. A., for the petitioner.

      J. L. Deveney, Esq., for the respondent.
    The Commissioner determined a deficiency of $621.95 for the calendar year 1924. Petitioner claims that at the end of 1924 the value of 200 shares of the capital stock of the Cross Mountain Coal Co. which he owned, and for which he had theretofore, paid $12,880, was not in excess of $Í5 a share and that he was therefore entitled to a deduction of $9,880 as a loss sustained within the taxable year.
    FINDINGS OF FACT.
    Petitioner is a resident of Knoxville, Tenn. In 1917 and 1918 he purchased ■ a total of 200 shares of the capital stock of the Cross Mountain Coal Co., a Tennessee corporation, for $12,880. The total outstanding capital stock of the Coal Company during the year 1924 was 5,000 shares of the par value of $500,000. On July 31, 1924, the Coal Company sold all of its assets for $75,000, of which $10,000 was paid in cash and $05,000 by interest-bearing promissory notes falling due over a period of years. The corporation was not at the end of 1924 and has not since been dissolved. No distribution in complete or partial liquidation of the capital stock has been made. Prior to the sale of its assets the corporation was engaged in. mining and selling coal.
    At December 31, 1924, the Cross Mountain Coal Co. had a net worth in excess of $73,000 as shown by its books and for the year 1925 it .had a net income of $2,957. The net worth of the company at the close of the year 1925 was in excess of $74,000. At the close of the calendar year 1924 there were certain contingent liabilities not shown upon the books consisting of a claim by the Commissioner of Internal Revenue for taxes for prior years in an amount determined by him to be approximately $65,000 and other minor claims for breach of contracts and attorneys’ fees.
    The determination of the Commissioner of additional income and profits tax for 1922 and prior years was duly appealed to this Board and such proceeding was decided favorably to the Cross Mountain Coal Co. in an opinion reported in 2 B. T. A. 587. The Commissioner did not wholly acquiesce in the Board’s decision and now claims an additional tax for 1922 and prior years in the amount of $12,390.43. The Commissioner denied the loss claimed by the petitioner through the decline in the value of the stock owned by him in the Cross Mountain Coal Co. and determined a deficiency of $621.95 for the calendar year 1924.
   OPINION.

Littleton :

Petitioner’s claim of a loss in 1924 is based upon the decline in the value of stock owned by him in the Cross Mountain Coal Co. The corporation has not to this date been dissolved nor has any distribution been made by it to its stockholders in liquidation; so far as appears from the evidence the corporation may con-fcinue in existence indefinitely and again actively engage in carrying on a business. Petitioner has continuously owned his stock since the date of its purchase in 1917 and 1918. Its value may have fluctuated much since that time but the decline in value of the property does not give rise to a deductible loss under the statute any more than does the increase of the market value of the property owned give rise to taxable income. The evidence does not show and the petitioner does not claim that the stock was worthless at the end of 1924. Until it is clearly shown that stock owned in a corporation which is still in existence and has assets is in fact worthless and there is no probability that any portion of the investment will ever be recovered, no deductible loss under the statute has been sustained. See Appeal of E. O. Walgren, 4 B. T. A. 1066; J. J. Melick v. Commissioner, 6 B. T. A. 70; Appeal of George C. Ryder, 2 B. T. A. 1060. The term “ losses sustained ” conveys the idea of a final termination of a transaction in connection with which the investment was made and the loss claimed. See New York Life Insurance Co. v. Edwards, 271 U. S. 109. See Corn Exchange Bank v. Commissioner, 6 B. T. A. 158. We think the Commissioner correctly denied the deduction claimed.

Judgment will he entered for the respondent.


author: MuedoCK :

text:
    Consumers’ Ice & Cold Storage Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8551.
    Promulgated May 10, 1927.

      Edwin E. Gano, C. P. A., for the petitioner.

      J. L. Deveney, Esq., for the respondent.
   MuedoCK :

Income and excess-profits taxes for the calendar years 1919, 1920, and 1921, are in controversy. The Commissioner determined a deficiency for 1919, amounting to $2,826.30 and overassess-ments for the other two years in the amount of $281.04 for 1920 and $72.90 for 1921. The petitioner alleges that the Commissioner charged certain expenditures totaling $7,484 to capital account, whereas he should have allowed them as deductions for ordinary and necessary expense. -

FINDINGS OF FACT.

The petitioner is a New Jersey corporation, with its principal office at Elizabeth.

Wooden beams in the cooler house were badly sagged and were replaced by iron girders in 1919.

Old boiler fronts were cracked and warped and could not be repaired or used any longer. They were replaced by three cast-iron fronts in 1919.

Boilers had been in use for thirteen years. The brick work had many cracks in it. It was necessary for the first time since the boilers were installed to reset them. They had had little repair and were dangerous. In 1919, the walls were taken down. The boilers were blocked up by a rigger and reset. At this time the boilers were raised about three feet higher than formerly in order to get better results from bituminous coal, which was used to fire them. These were general repairs and were not such as were ordinarily made from year to year. After these improvements the boilers were in condition to last for at least ten years, whereas before they would not have lasted another year.

This work was all paid for during 1919. It was begun in the fall and all completed before the next year. The board of directors at a regular meeting approved rebuilding the boilers.

The petitioner expended $7,484 in making all of the improvements which are in dispute.

In 1919, the petitioner had an unusual demand for ice and pushed ' its plant to the utmost.

Judgment will be entered for the respondent.


author: SteRnhagen:

text:
    Liberty Baking Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6781.
    Promulgated May 10, 1927.
    1. The usefulness of wrapping paper was changed by reason of a change in the size of petitioner’s loaves so that two wrappers were needed for a loaf instead of one. Held, no deductible loss or reduction of inventory.
    2. Loss through demolition of buildings held not determinable from the evidence.

      Arthur J. Farber, G. P. A., for the petitioner.

      Thomas M. Wilhins, Fsg., for the respondent.
    Deficiency of $10,339, excess profits tax for the calendar year 1918. The Commissioner refused to allow an alleged loss in value of bread wrappers and a deduction of the alleged value of buildings demolished during the year.
    FINDINGS OF FACT.
    The petitioner is a Pennsylvania corporation conducting a baking business in Pittsburgh.
    During the war the petitioner manufactured loaves of bread from substitute materials in accordance with a so-called “ substitute order ” of tbe United States Food Administration. The loaves so manufactured were smaller than the loaves previously made by petitioner and required smaller wrappers. The name “ Victory ” was adopted for this bread, and a large supply of small wrappers with this name appearing thereon was purchased at a cost of 20.7 cents a pound.
    In November, 1918, the United States Food Administration, without prior notice, rescinded its “ substitute order.” The petitioner, in common with other bakers, started the manufacture of a full wheat bread. The loaves of this bread were larger than the loaves of “ Victory ” bread, and the wrappers used for that bread were not large enough to cover the full wheat loaf. Petitioner immediately placed orders for larger wrappers, but they were not delivered until February or March of the following year. Until the larger wrappers were secured it was necessary to use two of the old wrappers to cover each loaf of the full wheat bread.
    The following is a portion of the minutes of the meeting of the board of directors held December 16, 1918:
    Our inventory at close of business December 28, 1918, showed $11,370.90 invested in Victory Bread Wrappers. Owing to the discontinuance of the substitute order for wheat flour, the full wheat loaf gives us a greater volume of larger loaf, compelling us to use two wrappers instead of one for each loaf. This being the ease and in order to attempt to .use up the stock, it was suggested that one-half (%) the amount be charged to Profit and Loss. On motion duly put and carried, fifty per cent (50%) of the amount, ($5,685.45) was ordered charged off our books to take care of this item.
    The small wrappers could have been replaced on December 31, 1918, for substantially the same price paid by petitioner, 20.7 cents.
    In November, 1916, the petitioner purchased at a cost of $28,200 real property adjoining its own. On this land there were two frame buildings and one brick building. The age of these buildings is not known. The purchase was made because petitioner needed more room for storage of automobiles and for manufacturing facilities, and the property was adaptable for the petitioner’s uses and was acquired for those uses.
    The following are extracts from the minutes of the meeting of the board of directors on November 6, 1916, and of the stockholders on November 15, 1916:
    The secretary reported the possibility of purchasing 45 feet, more or less, of the Smith property adjoining our plant on Houston Street, together with the buildings erected thereon, for the sum of $24,000.00 cash and our equity in the property of the company on Carrón Street. After much discussion the following resolution was offered by the secretary, duly seconded and carried:
    Besoived that the best interests of the company will be protected by acquiring additional land on Houston Street for future extensions, Therefore, the President and Secretary are hereby authorized to enter into an agreement for the purchase of 45 feet, more or less, of the Ira D. Smith property situated on Houston Street, 7th Ward, adjoining present plant of the company, for the sum of $24,000.00 cash, together with the equity of the company of $4,200.00 in the property situated on Carrón Street, 7th Ward, City of Pittsburgh, and to execute and deliver deed of the company for said Carrón Street property. * # * # * * *
    Resolution : — Whereas, on account of the rapid increase of the business of the “ Liberty Baking Company ” it has been deemed advisable to arrange for funds to be used in the purchase of additional ground on Houston Street. Therefore:
    Resolved that the board' of directors of this company be and the same are hereby authorized to raise such sums, not exceeding $24,000.00, as may be required for said purchase, and to execute and to deliver to the City Deposit Bank of Pittsburgh said notes of this company secured by collateral Bond and Mortgage on the property purchased, and also any agreements that may be required by said bank and on such term's as the board of directors of this company may deem requisite for the best interest thereof. [Minutes of directors’ meeting of November 6, 1910.]
    Whereas, on account of the rapid increase of the business of the “Liberty Baking Company,” it has been deemed advisable that the best interests of the Company will be protected by acquiring additional land on-Houston Street for future extensions. Therefore,
    Resolved, that it is the desire of the stockholders that additional land be acquired by the Company on Houston Street, Pittsburgh, for future extension, and therefore, the President and Secretary of the -Company are hereby authorized to enter into an agreement to purchase forty-ñve (45) feet, more or less, of the Ira D. Smith property on Houston Street, Seventh Ward, Pittsburgh, adjoining the present plant of the Company, for the sum of Twenty-four Thousand ($24,000.00) Dollars, together with the equity of the Company amounting to Porty-two PXundred ($4200.00) Dollars in the property situated on Carrón Street, Seventh Ward, Pittsburgh, and are further authorized, for the purpose of consummating said agreement, to pay the said sum of Twenty-four Thousand ($24,000,00) Dollars and to execute and deliver the deed of the Company for the said Carrón Street property.
    Resolution : — Whereas, on account of the rapid increase of the business of the “ Liberty Baking Company ” it has been deemed advisable to arrange for funds to be used in the purchase of additional ground on Houston Street. Therefore:
    Resolved that the Board of Directors of this Company be and the same are hereby authorized to raise such sums, not exceeding Twenty-four Thousand ($24,000.00) Dollars, as may be required for said purchase, and to execute and deliver to the City Deposit Bank of Pittsburgh said notes of this Company secured by collateral Bond and Mortgage on the property purchased, and also any agreements that may be required by said bank and on suqh terms as the Board of Directors of this Company may deem requisite for the best interest thereof. [Minutes of stockholders’ meeting of November 15, 1916.]
    In 1918, due to increased business, the petitioner contemplated the erection of more buildings, architects were employed and plans prepared. The frame buildings .on the property acquired in November, 1916, were destroyed, but the brick building was only partly demolished, the third floor thereof housing facilities which were an integral part of petitioner’s manufacturing processes. The lower floors of this building, used for storage purposes, were vacated. The petitioner’s plans were discontinued, however, at the request of the War Industries Board.
    The following are extracts from the minutes of meetings of tlie board of directors on June 26, September 10, and December 16, 1918, which relate to these matters:
    Tlie Secretary presented an agreement for the purchase of twenty-five feet additional frontage oh Houston Street, running back to the railroad, from Ira D. Smith for the sum of eleven thousand eight hundred dollars ($11,800.00) cash, (he same to be closed on or about August 1st.
    After considerable discussion and on motion duly, put and carried, the President and Secretary were hereby authorized to sign said agreement and take title to tlie property in the name of the Conrpany to be used for future extensions. [Minutes of June 20, 1018.]
    After considerable discussion relative to our building programme, it was deemed for the best interests of the Company that we acquire fifty feet additional land on Houston Street, adjoining three-story brick recently acquired from Smith, to house separate boiler room and to increase car track facilities. On motion of J. B. Stevenson, seconded by John Bour, authority was granted to enter into an agreement with the owner, Mr. James A. Johnson, for the purchase of tlie property upon the best terms procurable. [Minutes of September 10, 1918.]
    The Secretary reports our inability to proceed with our proposed extensions on account of refusal of permit from the War Industries Board, Washington, D. C., copy of which letter was read and ordered spread on the minutes. The letter follows:
    WAR INDUSTRIES BOARD Washington
    B. M. Baruch Chairman
    In your reply refer to DRM

    November 5th, 1918.
    Prom: Non-War Construction Section, Priorities Division.
    To: Liberty Baking Company, Pittsburgh, Pa.
    Subject: Proposed extension to your Baking Plant.
    Reference your letter September 25th, addressed to Chairman Council of National Defense for Alle’y Co., Old City Hall, Pittsburgh, Pa.
    1. The War Industries Board has given careful consideration to this application and cannot look with favor upon it at this time. We are advised that there are ample baking facilities in Pittsburgh and vicinity at the present time; therefore, owing to the great need of the war program for all available labor and material, we do not believe that any of either ought to be taken for work that can be postponed. We realize that perhaps 'this may mean some inconvenience to you, but we ask you to cheerfully undergo such inconvenience in order to.help the National program and we confidently expect you to do so.

      2. We are sending copy of this letter to the State Council of Defense, Philadelphia, Pa., for their information.
    2-r (Signed) D. R. McLennan,

      Chief Non-War Construction Section.

    On the strength of this letter the Secretary reports having settled the lease for temporary quarters wo had provided with the West Penn Motor Sales Company for the sum of one hundred fifty dollars ($150.00) ; and also reports having applied for and being granted permit to move one of the frame buildings and to erect temporary sheds for housing during the winter.
    Bill of C. D. Cooley, architect, was presented amounting to forty-six hundred dollars ($4,600.00), based on four per cent (4%) of an estimated cost of one hundred fifteen thousand dollars ($115,000.00).
    The Board finding ourselves unable to proceed with the building and also we now find, due to the Government rescinding the substitute and other bakery regulation orders, that the business has declined and that there is now no imperative reason for our proceeding with the extensions until such time as the demands may compel us to do so. Having anticipated the possibility of the war lasting three to five years and the continuance of the demand for bread, which latter, for several months past, has been sufficient to double our output, the proposed extensions were an attempt to cope with the difficulties.
    After considerable discussion and for the reasons above stated, the Chairman suggested that a motion to dispose of the question would be in order. On motion of J. B. Stevenson, seconded by John Bour, duly put and carried, authority was granted to pay for the plans of C. D. Cooley amounting to forty-six hundred dollars ($4,600.00), the same to be considered a loss and the amount to be charged off.
    * * * * * *
    The Secretary presented an agreement from the Truscon Steel Company in which they offered to cancel our contract placed last August for steel for our proposed new building for the sum of fourteen hundred sixty dollars ($1,460.00) on the following conditions:
    Should we desire to proceed with our building during 1919 and in the event of our contracting prior to September 1st and they being the successful bidders, that this amount will be applied against the contract. They claim that engineering on the job put them to this expense.
    On motion of J. B. Stevenson, seconded by L. P. Schmitt, the Secretary was authorized to accept the proposal and close the matter accordingly, charging the items to Profit and Loss. [Minutes of December 16, 1918.]
   OPINION.

SteRnhagen:

The petitioner contends that its net income has been overstated by respondent through the disallowance of two items — the alleged loss in respect of wrapping paper, and the alleged loss of buildings demolished.

The issue as to the wrapping paper is not clearly framed. It is referred to as a “ loss,” although not under section 234, but as a closing inventory of supplies. The fact relied upon by petitioner is that the so-called Victory Wrappers were too small for its postwar loaves and could only be used by applying two wrappers to each loaf This is said to have reduced the usefulness of the wrappers by one-half, and hence it is contended that one-half of the cost should be written down out of income. Market value was no less than cost; only the usefulness was changed. In our opinion there was neither loss nor reduced inventory, and the respondent is sustained.

The second issue lacks evidence upon which the alleged loss can be found. However convincing may be the evidence that the buildings were bought for their own sake and not as an incidental burden upon the land, so that their demolition may have caused a loss, it is not possible from the evidence to determine the loss. The cost of the buildings as distinguished from the land or as proportioned to the whole, the extent of intervening exhaustion applicable or applied to such cost, and the extent of demolition in proportion to the cost, are not proved. The respondent is on this issue sustained.

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