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    Merchants National Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8179.
    Promulgated April 30, 1927.
    1. Where a bank keeps its books of account on the cash receipts and disbursements basis, except as to interest on securities owned, it will not be allowed to report interest on securities owned on the accrual .basis, even though its books have been so .kept over a long period of years.
    2. Value of good will determined.

      H. A. Mihills, C. P. A., for the petitioner.
    ■ Chas. H. Owrl, Esq., for the respondent.
    This proceeding involves a deficiency for the calendar year 1920 in the amount of $7,454.91. The sixty-day notice, notifying the petitioner of’ the deficiency for 1920, showed an overassessment for 1919, and that year will be considered only in so far as it may affect 1920.
    The errors assigned by the petitioner follow:
    (1) The Commissioner erroneously eliminated from taxable income as shown by the books, the interest which had been accrued on securities owned, and included in lieu thereof interest received on securities owned.
    (2) The Commissioner erroneously excluded from invested capital the amount of $294,254.64 representing good will of the First National Bank acquired by the petitioner for cash on September 9, 1916.
    FINDINGS OE FACT.
    The petitioner is a national bank with principal office in Baltimore, Md., and is a successor to the Merchants-Mechanics National Bank.
    The books of the petitioner have been kept upon the basis of cash received and disbursed, with the exception of interest on securities owned in respect of which the accrual basis has been used. This method was followed not only for the year 1920, but also for many years prior thereto. The petitioner filed its income and profits-tax return for 1920 on the basis on which its books were kept. In the audit of the return, the Commissioner eliminated from taxable income as shown by the return the interest which had been accrued on securities owned and substituted therefor interest received on such securities.
    The facts with respect to the second issue are somewhat complicated and are, therefore, set out in some detail.
    Prior to July, 1916, the officers of the Merchants-Mechanics National Bank and the First National Bank had been considering plans by which the two banks would unite. Finally on July 16, 1916, the following plan of merger was prepared in a circular mailed to all stockholders:
    The Merchants-Mechanics National Bank of Baltimore and the First National Bank of Baltimore are to be merged in accordance with the following plan:
    (1) Name. The name of the Bank resulting from the merger shall he the “ Merchants-Mechanics First National Bank of Baltimore ”, or such other name as may be approved by a majority of the Directors of each of the two Banks.
    (2) Teems oe Mekger. The merger will be effected as follows:
    (a) The Merchants-Mechanics National Bank will increase its capital stock from $2,000,000 to $2,500,000 and dispose of the increase in accordance with the plan;
    (b) The Merchants-Mechanics National Bank will acquire by purchase or otherwise all of the assets (save the retained assets hereinafter mentioned) and assume all the liabilities of the First National Bank;

      (c) The First National Bank will retain for the benefit of its stockholders the Bank Building and approximately $76,000 face amount of commercial paper to be designated by the Merchants-Mechanics National Bank, subject to the payment to the latter Bank of $96,000. The retained assets shall be disposed of in such manner as the First National Bank or its liquidating committee may determine, and may be transferred to a new corporation or to a trustee, or otherwise, and the stock of such corporation or certificates of beneficial interest therein, or other evidences of their interest, distributed to the stockholders of the First National Bank.
    (3) Bights and Privileges oe Stockholders. Merchants-Mechanics National Bank Stockholders to retain their present holdings without change. On completion of the merger and when called for by the Directors, certificates of stock must be exchanged for new certificates.
    The stockholders of the Merchants-Mechanics National Bank have the right in proportion to their holdings to participate in a syndicate to underwrite the increased issue of stock, and to purchase and sell such part as may not be required for delivery to the stockholders of the First National Bank, as hereinafter mentioned.
    First National Bank stockholders receive for each share held by them—
    (a) $140 per share in cash, or at their option in lieu of each, 6 shares of the capital stock of the Merchants-Mechanics National Bank of Baltimore;
    (b) Certificates representing the interest in the retained assets, subject to the obligations stated.
    (4) Deposit oe Stock of First National Bank. Stockholders of the First National Bank approving of the plan must deposit their shares, endorsed so as to be negotiable by delivery, with H. B. AVilcox, Blanchard Bandall and E. Asbury Davis at the First National Bank, on or before the 26th day of August, 1916, or such other date as said Committee may fix.
    Beceipts or certificates shall be issued by said Committee by its agent for said deposited shares in such form as they may prescribe. On completion of the merger, the liquidation of the First National Bank, and on due surrender of the deposit certificates, stockholders will be entitled to receive the stipulated amount of cash or shares of stock in the merged bank in accordance with their election, together with the certificate or other evidence of their interest in the retained assets.
    First National Bank stockholders must elect whether they will accept $140 cash or said 6 shares of stock by delivering such election in writing to the said H. B. AVilcox et al., Committee, on or before the 25th day of August, 1916. Each stockholder failing to file such election shall be deemed to have elected to take cash.
    Tho said Committee, in order to effect said merger, are authorized to have said shares registered in such name as they may determine, give proxies to vote said shares and to receive and receipt for dividends in liquidation thereon, and to surrender said shares for cancellation to the First National Bank or its liquidating committee; use the shares of the stockholders who elect to take stock in the Merchants-Mechanics National Bank, or the dividend thereon or the proceeds thereof to acquire said shares and make such agreement as may be necessary for that purpose; and generally exercise all powers of ownership to such extent as, in their judgment may be necessary or expedient to carry, out the plan.
    (6) Underwriting Syndicate and Bight to Participate. At the request of the officers of both Banks, Alexander Brown & Sons have undertaken to form a syndicate for the purchase of the entire increased issue of 60,000 shares of the Merchants-Mechanics First National Bank, $28. per share, and to exchange and resell the same. The aggregate of the syndicate subscriptions will he $1,400,000.
    The shares necessary to make delivery to the First National Bank stockholders who elect to take the stock in place of $140 cash, will be delivered to them and the balance held and disposed of for the account of the syndicate participants.
    The syndicate will receive from the Merchants-Meehanics National Bank a commission of 1 %% on the face amount of the subscription of $1,400,000.
    Syndicate Participants. To insure the completion of the syndicate in the event of the failure of the stockholders to subscribe for the total amount of the new stock, a number of Directors have expressed their willingness to become participants. Bach Director of the two Banks is entitled to subscribe to his proportionate share of the total subscription; the share of each is $42,420. No Director is obliged to subscribe. Directors’ subscriptions must be made as and within the time hereinafter provided for, otherwise their right will lapse.
    Any portion of the total subscription not taken by the directors may be taken by Alexander Brown and Sons, or any other persons or corporations they may select. All subscriptions are subject to reduction to the extent of the subscription to the syndicate made by the stockholders of the Merchants-Meehanics National Bank, and such subscriptions shall after reduction be treated as if originally made for the reduced amount.
    Stookholdeks’ Pabticipation. Each stockholder of the Merchants-Meehanics National Bank, shall have the preferential right to become a participant in the syndicate in proportion to his holdings, i. e., one share of new stock for each four shares held by him at $28.00 per share; fractional shares to be disregarded.
    All subscriptions must be made in the form prescribed by the Syndicate Managers and delivered at the Merchants-Meehanics National Bank not later than the 25th day of August, 1916, otherwise the right to subscribe will lapse.
    Pabticipants’ Obligations. Each syndicate participant must pay the amount of his subscription, if and when it is called for by the Syndicate Managers. The Managers are authorized on behalf of the syndicate participants to purchase and subscribe for said increased issue of stock and to pay therefor. The Managers are authorized, in lieu of calling for subscriptions, to borrow the money necessary for the payment of said shares, and to pledge in the usual form said shares and the subscribers’ obligation with itself or any other firm or corporation as security therefor; to sell the shares not necessary for delivery to the First National Bank stockholders at public or private sale and at such prices as the Managers may fix; to buy and sell shares of either Bank for the account of the syndicate; to employ brokers and agents for the sale of the stock and fix the commission therefor.
    The separate subscriptions of participants to the syndicate herein referred to shall constitute them members of the syndicate and together constitute the agreement between the subscribers and with the Managers. The obligation of each subscriber is a separate obligation for the amount of his subscription. No subscriber shall be liable for the default of any other.
    The syndicate shall terminate on the 31st day of December, 1916, unless extended by the Managers for such period as such firm may fix, not exceeding six months, or unless earlier terminated by the Managers.
    In case for any reason the merger plan or the syndicate should be abandoned, then the stock deposited or money paid shall be returned and the Managers and Syndicate Members discharged from all liability.
    On the termination of the syndicate and on the payment of all of the subscribers’ obligations as participants therein all of the profits of the syndicate, together with any shares of stock remaining unsold, shall be distributed among the syndicate participants in proportion to their interests.
    The Syndicate Managers are paid for their services of drafting plans for conducting the plan of merger, for conducting negotiations thereto, and therefore make no charge for their services as Syndicate Managers. They shall be entitled to be reimbursed for all their expense, including counsel fees, brokerage commissions, and all other usual expenses.
    The Syndicate Managers shall not be responsible for the completion of the underwriting or otherwise with respect thereto, except for the exercise of good faith in their efforts to consummate the merger.
    The foregoing is the correct official statement of the merger plan.
    Douglas H. Thomas, Pres.

    Dated July 16, 1916. H. B. Wilcox, Pres.

    After various meetings of the board of directors of the Merchants-Mechanics National Bank at which the proposed merger was considered favorably, the following resolutions were adopted at a special meeting of the stockholders of the Merchants-Mechanics National Bank on August 28, 1916 :
    Resolved, That the plan for merger of the Merchants-Mechanics National Bank of Baltimore and the First National Bank of Baltimore, dated August 16, 1916. authenticated by the signature of Mr. Douglas H. Thomas, President, and submitted to this meeting, be and the same is hereby approved and the directors and officers of this bank be and they are hereby authorized and directed to take such proceedings, execute and deliver such instruments, and otherwise do whatever may be necessary or expedient to consummate and carry out said plan of merger.
    The judges and tellers reported the vote on the resolution and the Chairman announced the same to be as follows:
    Votes in favor of the resolution 146,217 shares, of which 97 shares were voted in person and the balance by proxy.
    Votes against the resolution — None.
    The resolution was thereupon declared adopted.
    Upon motion of Mr. Stoneburner seconded by Mr. Appold the following resolutions were then passed:
    Resolved, That the corporate name the Merchants-Mechanics National Bank of Baltimore is hereby changed to the Merchants Mechanics First National Bank of Baltimore; that to this end Section 6 of the Articles of Association be amended to be changed to read as follows: The Merchants-Mechanics First National Bank of Baltimore.
    Resolved, That under the provisions of the Act of May, 1886, the capital stock of this association be increased in the sum of $500,000 maiding the total capital stock $2,500,000; divided like the outstanding stock into shares of the same par value.
    Resolved, That this bank sell 50,000 shares of the par value of $10. each constituting the increase of its capital stock, authorized at a meeting held on the 28th day of August 1916, at $28. per share; the stock to be entitled equal and rateably with all stock heretofore issued to all dividends declared on or after this day: That the subscriptions to said stock be payable on the 11th day of September 1916, without interest, or upon such earlier or later date that the Board of Directors of this bank may on two days written notice require.

      Resolved, That all stockholders of record August 26, 1916, be given an opportunity until September 6, 1916, to subscribe to said increase at said price rateably, i. e., and in proportion which the number of shares held by him on August 28, 1916 bears to the total number issued and outstanding on said day; that notice of said increase and limitation of the time for the exercise of said preferential right be given (o all stockholders who have not heretofore waived said right, by mail posted on or before the 29th day of August, 1916. Subscriptions made in the exercise of said preferential right must be made in writing and delivered to the Cashier of the bank on or before throe o’clock September 6, 1916, otherwise said preferential right shall lapse.
    Resolved, That all shares of stock forming part of the increased issue of 50,000 shares of the par value of $500,000 with respect to which the right of preferential subscription may have been heretofore waived or may be hereafter waived or may not be exercised as and within the time herein limited may be sold by the Bank to Alex, Brown & Sons and to such stockholders of this bank and directors of this bank as may be associated with them in such purchase, at the price of $28. per share above stated.
    Resolved, that the number of directors of this bank for the balance of the year 1916 or until the election and qualification of their successor be increased from sixteen, the number heretofore elected to twenty-two. This resolution shall not in any way alter or affect the provisions of the Articles of the Association providing that the Board shall consist of not less than five nor more than thirty stockholders.
    Resolved, that this Bank purchase from the First National Bank of Baltimore all of the following property, to wit:
    (1) All of the property of every nature and kind including good-will of the First National Bank of Baltimore (save as hereinafter excepted).
    (2) The note or other obligation of $95,000 of the First National Bank of Baltimore or at its option of the persons or corporations to which the excepted assets may be conveyed.
    The assets excepted from the sale consist of:
    (a) The lot and improvements situated at No. 17 South Street and running through to Holliday Street, used as a banking house by the First National Bank of Baltimore.
    (b) Commercial paper of the aggregate principal amount of $75,000 selected by the Merchants-Mechanics National Bank and specified on a list identified by the signatures of the President and Vice President or Cashier of this Bank and of said First National Bank of Baltimore.
    That this Bank pay for said property as follows:
    (a) That it assumes and pays all and every liability, including the obligations under every form of contract of said First National Bank of Baltimore.
    (b) Pay to the First National Bank of Baltimore $1,400,000.00. Delivery and payment to be made on September 11th or on such earlier date as the two Banks may agree on.
    The sale to be made as of September 11, 1916 and the property purchased and the liabilities assumed to be such as exist on said date. Said sale is made without representation or recourse.
    Resolved Further., that the Board of Directors and Officers of this Bank cause to be executed a formal contract for said purchase expressing the terms substantially as above stated and of such other provisions as said officers may api>rove.
    And that said Board of Directors and Officers are hereby authorized and directed to execute such instruments and do whatever may be necessary or expedient to consummate said purchase.

      Separate vote was taken on each resolution by ballot and in the case of each resolution the judges and tellers separately reported and the Ohairman separately announced the vote.
    In the case of each resolution there voted in favor of the adoption of the same stockholders holding 146,217 shares, of which 97 shares voted in person and 146,120 voted by proxy; and in the case of each resolution no shares were voted against the adoption of .the same. In all cases the shares voted by proxy were voted by Messrs. Harlan and Hose, proxies as above .stated.
    Pursuant to these resolutions the following sales agreement was entered into between two banks :
    SALES AGREEMENT
    This Agreement, made this 29th day of August, 1916, by and between the First National Bank of Baltimore, party of the first part and the Merchants-Mechanics National Bank of Baltimore, party of the second part.
    A plan for the merger of the Merchants-Mechanics National Bank of Baltimore and the First National Bank of Baltimore, dated July 16th, 1916, authenticated by the signatures of the Presidents of said Banks has been approved by the stockholders of each Bank, and the officers of each have been duly authorized to carry out and consummate the same.
    Pursuant to said plan and by virtue of the authority conferred upon them respectively by due action of the stockholders, the First National Bank of Baltimore has agreed to sell and the Merchants-Mechanics National Bank of Baltimore has agreed to buy all of the assets of the First National Bank of Baltimore; to define and express this said agreement this instrument is executed.
    Now, Therefore, This Agreement executed in consideration of the premises and of the sum of One Dollar and other valuable considerations by each of the said parties to the other paid, the receipt whereof is by them respectively acknowledged, witnesseth:—
    First: The First National Bank of Baltimore agrees to sell and deliver to the Merchants-Mechanics National Bank of Baltimore and • the Merchants-Mechanics National Bank of Baltimore, agrees to purchase from the First National Bank of Baltimore, all of the following property, to wit:
    (1) All of the property of every nature and kind, including good-will of the First National Bank of Baltimore (save as hereinafter expressly excepted).

      Commercial Paper excluded from the assets of the First National Banlc purchased hy the Merchants-Mechanics National BamJs.

    Alice H. & Bonio H. Bittle, dated June 9, 1913 Payable six months after date- $4, 250.
    Alice H. & Bonio H. Bittle, demand dated Oct. 18, 1913_ 800.
    Easton Flint & Spar Co., J. B. Hanna, Jan. 31, 1916 four months after date, due May 3, 1916_ 493. 27
    Lane Bros. Co. Sundry demand notes aggregating- 50, 895.
    Charles N. Evans, demand note dated April 1, 1914 with sundry collateral_ 7, 500.
    Chas. T. Leviness, demand note dated March 5, 1913 with sundry collateral_ 3,425.
    Woodlawn Cemetery Co. %d interest St. Paul Plot Syndicate-_ 7, 608. 33
    Balance of Jacob Foland note $39.80 endorsed by S. Kirson & Co. dated Nov. 8, 1915, 60 d, due Jan. 7, 1916_ 28. 40
    $75,000.00

      (2) The note or other obligation for $95,000 of the First National Bank of Baltimore or at its option of any persons or corporations to which the excepted or reserved property may be conveyed as hereinafter provided.
    The assets excepted from said agreement of said banks consisted of:
    (a) The lot of ground and improvements situate at No. 17 South Street and running through to Holliday Street, Baltimore, Maryland, and used as a banking house by the First National Bank of Baltimore.
    (b) Commercial paper of the aggregate principal amount of $75,000 selected by the Merchants-Mechanics National Bank of Baltimore and specified on a list attached hereto or identified by the signature of the President and Vice President or Cashier of each of said Banks.
    SECOND. The Merchants-Mechanics National Bank of Baltimore agrees—
    (a) To assume and pay all and every liability including the obligations under every form of contract of the First National Bank of Baltimore.
    (b) To pay the First National Bank of Baltimore $1,400,000.00.
    Third. The First National Bank of Baltimore retains said excepted or reserved assets free from all claims hereunder, save the payment of said obligation of $95,000. and interest at the rate of 4% per cent per annum above referred to and no distribution of said reserved assets or the proceeds thereof shall bo made to the stockholders of said First National Bank of Baltimore until said $95,000 shall have been paid. Said First National Bank of Baltimore may cause said assets to be transferred to individuals or to corporations for such consideration as it may see fit, provided that immediately upon such transfer such successor owner shall execute and deliver to the Merchants-Mechanics National Bank of Baltimore a note for $95,000, with an agreement that none of said property transferred shall be mortgaged or similarly encumbered without the consent of the holder of said note and upon such delivery all liability of said First National Bank of Baltimore or of its assets for the payment of said $95,000. shall be discharged and terminate.
    Fourth. Delivery and payments to be made on September 11, 1916, or on such earlier or later date as the Board of Directors of the Merchants-Mechanics National Bank of Baltimore and the Board of Directors of the First National Bank of Baltimore or its liquidating committee or agent may agree upon.
    Fifth. The sale is made as of September 11th, 1916, or as of such earlier or later date as may be so agreed upon for delivery. The property sold and to be delivered shall be the said property as it exists on said delivery date and the liabilities assumed shall be the liabilities as they exist on said delivery date. No change in title or right of possession shall take place and the right to conduct the business shall remain vested in the First National Bank of Baltimore until said 11th day of September, 1916, or until said substituted date for delivery as fully as if this agreement had not been made, save that no dividend shall be declared or paid on the stock of the said Bank before such date.
    The purchaser has made such examination of the property so purchased as it desires and the sale is made without representation or recourse, and any change in its assets or liabilities, profits or losses now existing or occurring before said delivery date shall inure to the benefit of or be borne by the purchaser; it being intended that the said purchase price of $1,400,000, together with the proceeds of the retained assets (subject as to the reserved assets of the payment of $95,000) shall without deduction be available for distribution to the stockholders of the First National Bank of Baltimore as dividends in liquidation.
    Sixth. Proceedings for the change of the name of the Merchants-Mechanics National Bank of Baltimore have been begun and it is intended that the term “ Merchants-Mechanics National Bank of Baltimore ” where herein expressed shall include also said Merchants-Mechanics First National Bank of Baltimore, save where the context shows that a different meaning is intended.
    Appropriate resolutions to carry out the foregoing resolutions of August 28, 1916, and sales agreement (in so far as the Merchants-Mechanics National Bank was concerned) were adopted by the board of directors of the Merchants-Mechanics National Bank on August 29, 1916.
    The sales agreement was carried out substantially as contemplated, with Alexander Brown & Sons, bankers, acting as Syndicate Managers. The stock of the First National Bank was selling on the market at this time at approximately $145 per share and that of the Merchants-Mechanics National Bank at $28 to $30 per share.
    Prior to the merger, the Merchants-Mechanics National Bank took the necessary steps- to have its name changed to the Merchants-Mechanics First National Bank of Baltimore, Maryland, and to secure the issuance of 50,000 additional shares of stock of a par value of $500,000. Under the terms of the merger, all of the stockholders of the First National Bank exchanged their stock for stock of the petitioner except a small minority to whom it was necessary to pay cash under the terms of the merger arrangement to the extent of $49,280. After the syndicate managers had secured all of the stock of the First National Bank, either by purchase for cash or exchange of stock for stock, the entire capital stock of the First National Bank was delivered to the petitioner. The petitioner, on September 11, 1916, took over all of the assets and assumed the liabilities of the First National Bank, except to the extent indicated in the sales agreement. The stock of the First National Bank was canceled and the First National Bank was liquidated.
    On September 9, 1916, entries were- made in the general books of the petitioner in accordance with the following statements:
    1. Debits Alex. Brown & Sons, Syndicate Managers account at Merchants-Mecbanies First National Bank, $1,400,000. payable to Merchants-Mechanics First National Bank upon delivery to Syndicate Managers of $500,000 par value of stock.
    2. Merchants-Mechanics First National Bank gives cheque for $1,400,000 to Liquidating Committee, First National Bank.
    3. Liquidating Committee deposits this cheque in Merchants-Mechanics First National Bank to account of Liquidating Committee.
    4. Liquidating Committee orders its account charged in favor of Stockholders Committee First National Bank, $1,350,720 and proceeds to check out balance in favor of stockholders who do not exchange stock at $140.00 per share.
    5. Stockholders Committee orders its account charged in favor of Alex. Brown & Sons, Syndicate Managers, for $1,350,720, Alex. Brown & Sons delivering stock to stockholders committee therefor.

      On September 11, 1916, at a meeting of the board of directors of petitioner, the chairman of the board informed the board that under the iilan of the merger the executive officers had agreed to appraise the assets of the petitioner, reducing the same to a conservative valuation and that there had been charged to profit and loss the sum of $641,590.36, which action was approved. The assets reduced were real estate, stocks and bonds, overdue paper, and demand and time loans and, in addition, one item called “Account good will First National Bank, $300,000.00.”
    At the time the merger took place, the First National Bank had been in business since 1863, and was one of the largest banks in Baltimore, that of the petitioner being the largest.- It had always been successful and had paid dividends at the rate'of 7 per cent. Its combined capital and undivided profits on September 9, 1916, was $1,105,745.36, which represented a conservative cash value of the tangible assets acquired. The bank building, which was included ’ among the excepted assets, was not carried as an asset on the books .of the First National Bank.
    In order that the business as previously carried on by the First National Bank might be carried on in an uninterrupted manner by the petitioner, many of the officers and employees of the former bank were transferred to the latter aad occupied similar positions with the petitioner. The president of the First National Bank became a director and executive officer of the petitioner and is now chairman of its board of directors. Depositors and customers of the First National Bank became depositors and customers of the petitioner.
    No good will has ever been carried either on the books of the petitioner or those of the First National Bank. The failure to carry good will was not because of an absence of good will, but because of rulings by the Comptroller of the Currency which prohibited such a practice.
    The value of the good will which the petitioner claims should be allowed in determining invested capital for the year on appeal is represented by the difference between the net worth of the First National Bank at the time of the merger, $1,105,745.36 and $1,400,000, the basis upon which the stock of the First National Bank was valued for the purposes of the merger. The reason for the disallowance as assigned by the Commissioner in the notice of deficiency was:
    The restoration of good will for invested capital claimed to have been acquired in 1016 cannot he allowed for the reason that the evidence does not show that a reorganization took place and the stocks issued for the assets are presumed to represent the actual cash value of the assets so acquired. Further, there does not appear evidence to show that the transaction was a cash one.

       Probably Is a typographical error and should be July 16, 1916.

   OPINION.

Littleton :

The contention advanced by the petitioner to the effect that it should be allowed to report a part of its income on the accrual basis when it is otherwise on the cash receipts and disbursements basis has previously been decided by the Board adverse to its contentions, Appeal of Chatham & Phenix National Bank, 1 B. T. A. 460; Appeal of Bank of Hartsville, 1 B. T. A. 920. In the Appeal of Madison & Kedzie State Bank, 1 B. T. A. 922, the Board said:

When a bank keeps its books of account on a cash basis, discount is income only when it is received; upon an accrual basis discount becomes income as it is earned. •

We fail to find anything in the petitioner’s argument as to consistency which would cause us to change our views previously expressed. See Appeal of Henry Reubel, 1 B. T. A. 676.

The second contention advanced by the petitioner is that the Commissioner erroneously refused to permit it to include good will in invested capital, which it acquired in the acquisition of the assets of the First National Bank through the merger of this bank and the petitioner in 1916.

The substance of the transaction in question is that after a basis of merger had been agreed upon, the entire capital stock of the First National Bank, $1,000,000, was acquired by the petitioner through an exchange of $500,000 additional stock issued by it. The exchange was handled through sjmdicate managers, with whom the additional stock was deposited and who made the exchange with the stockholders of the First National to the extent they elected to take stock, which all did except in the case of a small minority who elected to take cash and to whom it was necessary to pay cash in the amount of $49,280, which cash was obtained by the sale of a sufficient amount of the additional stock at $28 per share. After the stock was turned over to the petitioner, it effected a liquidation of the First National Bank and thereby became the owner of the assets of the First National Bank.

The Board is of the opinion that through the above transaction the petitioner acquired assets by the payment of tangible property therefor, viz., stock of the First National Bank. Prior to the time when liquidation was effected the petitioner was merely a stockholder, but after liquidation it was vested with full and complete ownership of the assets. Appeal of Regal Shoe Co., 1 B. T. A. 896. In the aforementioned decision we said:

It is undoubtedly true, as appears from the resolution of January 31, 1907, that the taxpayer at all times intended to acquire the business and assets of the three predecessor corporations, but the fact is that before it acquired these assets it had acquired the stock which the statute characterizes as tangible property, and the assets were acquired not for the stock of the taxpayer company but in liquidation of the stock of the other three corporations which it held. '

In order to dispose of this issue, two remaining questions must be answered:

(1) What was the cash value of the assets paid in?

(2) Was good will of a value of $294,254.64 paid in?

It does not seem that there can be much question that the entire assets paid in had a value at least equal to $1,400,000, the amount claimed therefor by the petitioner. While we do not have a specific cash valuation of the assets themselves, we do have an undisputed market value of the stock of both the buyer and the seller at the time of the merger. The market value of the stock of the former was $145 and was considered in the merger at $140, while the market value of the stock of the petitioner was from $28 to $30 and was considered in the merger at $28. Whether we take the 10,000 shares of the former at $140 or 50,000 shares of the petitioner at $28, we arrive at a total value in each instance of $1,400,000 which is the valuation claimed by the petitioner. Whether the market value of the petitioner’s stock was the same after the additional issue of stock is not definitely stated, though convincing evidence of its value then is shown by the fact that in its issuance the stockholders of the First National Bank, except a very small minority, willingly exchanged their stock for the new stock, when under the term of the merger they could have taken cash instead of stock. We consider the evidence sufficient to establish the cash value of the assets of the First National Bank at the time paid in to the petitioner of at least $1,400,000.

The remaining question is whether good will of a value equal to the difference between the net book value of the First National Bank when acquired or $1,105,745.36, and the $1,400,000 found above, represents good will.

The following paragraph from the sales agreement under which the merger took place and which refers to the assets to be taken over shows that whatever good will the First National Bank had and was capable of transfer, was acquired by the petitioner:

All of the property of every nature and kind, including good will of tlie First National Bank of Baltimore, (save as hereinafter expressly excepted.)

A national bank is capable of having good will as an asset and this has been recognized by the Commissioner, I. T. 1995, C. B. 111-1, p. 145.

The failure of either bank to carry good will on its books is explained by the rulings of the Comptroller of the Currency, which prohibit the showing of any good will upon a financial statement of a national bank. That the petitioner immediately charged off the good will which it considered was acquired in the merger is ascribable to the same reason as a failure to carry good will on its books.

That a bank which has been in business since 1863, had been paying dividends at the rate of 7 per cent on its capital stock, and had grown to the position of one of the leading banks in Baltimore, Md., did not thereby build up an intangible asset of substantial value— whether we call it going concern value or good will value is not material — does not impress the Board as tenable. The substantial line of deposits which came over to the petitioner was certainly of value. The further fact can not be overlooked that many of the officers and employees of the First National Bank came along to occupy similar positions with the petitioner, so that old customers would be assured of the same treatment accorded heretofore.

The further fact must not be overlooked that we are dealing with a national bank which is under strict Government supervision. When at any time tangible assets are being carried in excess of conservative valuation, the United States will require that the proper valuation be placed on the assets. This would indicate that the tangible assets as taken over by the petitioner were considered on a conservative present value at the time taken over.

Value of good will is a question of fact and a taxpayer claiming a value for good will must prove facts sufficient to show value thereof at date of acquistion. Appeal of Schulz Baking Co., 3 B. T. A. 470.

It is very difficult to establish the exact cash value of the intangible asset good will, but the Board is convinced from a consideration of all the evidence, that a valuation of intangibles based upon the difference between the net book value of the tangibles at date of acquisition, $1,105,745.36, and the amount paid therefor, $1,400,000, is fair and reasonable, and to this extent the appeal -of the petitioner is sustained. This amount is, of course, not subject to the usual limitations of acquisition of intangibles for stock since tangible assets of an equivalent cash value were given therefor.

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

Phillips concurs in the result only.


source: Caselaw Access Project

author: Littleton :

license: Public Domain

text:
    Ozark Mills, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4377.
    Promulgated April 30, 1927.
    Petitioner’s method of valuing raw cotton inventories on a cost basis by the use of perpetual inventories maintained by petitioner accepted in lieu of inventories submitted by the Commissioner or revised inventories on an average cost basis submitted by the petitioner.

      E. 8. Parher, Jr., Esq., for the petitioner.

      Harold Alien, Esq., for the respondent.
    The Commissioner determined deficiencies in income and profits tax for the fiscal year ending March 31, 1918, in the amount of $30,919.35, and for the fiscal year ending March 31, 1920, $15,678.33. The Commissioner determined no deficiency for the fiscal year ending March 31, 1919.
    The petitioner claims that the deficiency for the fiscal year ending March 31,1918, is $6,034.77, and that for the fiscal year ending March 31, 1920, there has been an overpayment of $19,035.83.
    The principal controversy concerns the valuation of raw cotton which was in its inventories for the years involved. The fiscal year ending March 31, 1919, is considered only in so far as it is necessary in a determination of the deficiencies for the other years.
    There is no disagreement between the parties as to the number of pounds of cotton on hand, in process or in finished goods at the beginning or end of any of the taxable years in question, nor is there any dispute that the actual cost of the cotton on hand at the end of each year was lower than replacement cost or market.
    FINDINGS OF FACT.
    Petitioner is a North Carolina corporation with principal office and place of business at Gastonia. Prior to and during a portion of the year 1917, petitioner was engaged in the manufacture of ordinary cotton yarn. In the year 1917 it made changes in its plant, installed new and additional machinery and began the manufacture of high-grade cotton yarn with what is known as an English process for use in the making of soft collars and silk goods. This meant a change from the manufacture of ordinary cotton yarn, requiring a low grade of cotton, to the manufacture of a higher grade of yarn, requiring a large percentage of' high-grade cotton. At that time petitioner was one in a very few, if not the only mill in the South so conducting its manufacturing operations. As a part of petitioner’s process cotton of many grades was mixed and used at the same time. Never less than ten bales and usually about forty-bales were opened at the same time and a certain quantity of cotton was taken from each bale and run through fifteen mixing machines. When the various grades of cotton became finished yarn, the cotton had been mixed thoroughly 2,948,000 times.
    The amount of high-priced and low-priced cotton used in the mixture of raw cotton that goes into the yarn depends upon the number of the yarns being manufactured at the time, that is, whether fine or coarse, and the kind of yarn being manufactured at any particular time depends upon market conditions. Because of this condition a supply of cotton of various grades is and was kept on hand sometimes for a period of two years. The keeping of cotton purchased from time to time on hand for a long period of time is further occasioned by the arrrangement of petitioner’s warehouse facilities. Its warehouse, having a capacity of fifteen hundred bales of cotton, a supply sufficient to run petitioner for six months, has but one opening on the platform alongside the railroad, and as cotton is purchased it is stored as far back in the warehouse as possible for convenience in storing so that the various grades of the last cotton purchased are stored near the warehouse opening. In withdrawing cotton from the warehouse for manufacturing purposes, the cotton last purchased of the grade required is used first, leaving the cotton earlier purchased of the different grades in the rear of the warehouse. Petitioner uses from two hundred to two hundred and fifty bales per month.
    Prior to and during the taxable years when cotton was purchased petitioner made a record upon its books of account of the date of purchase, the number of pounds, from whom purchased, and the price paid per pound. After purchases were received there was attached to each bale a tag containing this information and petitioner made a record in its cotton book of the particular bales, grade, cost, date of purchase, etc., of cotton withdrawn from the warehouse for manufacturing purposes but in the storing and handling of the cotton some of the tags were detached and lost, and in some instances tags detached by employees when withdrawing cotton from the warehouse never reached the accounting office, consequently no record was made of such withdrawals until a check was made of the cotton book with a physical inventory.
    In the foregoing manner a perpetual inventory was maintained from which it was possible to determine the cost of raw cotton on hand and the cost of cotton entering into the manufacturing process. No physical inventories were taken until March 31, 1920, for the purpose of ascertaining the total cotton on hand and, from the tags which might still be attached, the date of purchase and cost per pound of such cotton. The inventory at March 31, 1920, showed a difference (a decrease) from the perpetual inventory of approximately 48,500 pounds, which difference the petitioner priced by taking the average cost of cotton for the preceding year, and reduced the perpetual inventory by this amount, which resulting amount was used in its original returns as filed. The only other change in the inventories as used in its returns from that shown by the perpetual inventory, of which we have been advised, was at March 31, 1918, when the inventory as shown by the books was reduced $8,803.07 and explained as “ reduction in value.”

      In the revised inventories submitted to the Board, petitioner determined the cost per pound of raw cotton on hand at March 31,1918, March 81, 1919, and March 31, 1920, on a weighted average basis by taking into consideration the opening inventories of raw cotton and the purchases of raw cotton made during the year. The weighted average costs so obtained were as follows: March 31, 1918, 28.989 cents; March 31, 1919, 35.903 cents; and March 31, 1920, 53.118 cents. These costs were used in the petitioner’s revised inventories in valuing raw cotton which entered into goods in process and finished goods on hand at the above inventory dates, as well as the raw cotton inventory. The revisions as contended for by the petitioner were not made in the inventory at April 1, 1917.
    The Commissioner, on the other hand, failing to find a physical inventory of cotton on hand at the end of each of the fiscal years mentioned taken at cost, proceeded.to take from petitioner’s books the most recent purchases to the extent of the number of pounds of cotton contained in the raw cotton inventory and used the cost of these purchases as the cost of the cotton on hand at each inventory date. To determine the cost of raw cotton in goods in process and in finished goods, the Commissioner used a weighted average cost per pound arrived at from sufficient recent purchases to equal the opening inventory for each year. The weighted average costs so arrived at were as follows: April 1, 1917, 21.86 cents per pound, obtained from purchases made from October, 1916, through March, 1917; March 31,1918, 38.57 cents per pound, obtained from purchases made from October, 1917, through March 31, 1918; March 31, 1919, 38.9 cents per pound, obtained from purchases made from September, 1918, through January, 1919 (no purchases being made in February and March, 1919); and March 31, 1920, 80.6 cents per pound, obtained from purchases made from December, 1919, through March, 1920.
    The Commissioner made no allowance for waste in manufacturing operations. During each of the fiscal years the actual waste in the number of pounds of raw cotton entering into' the manufactured product was 30.69 per cent for the fiscal year ending March 31, 1918, 28.63 per cent for the fiscal year ending March 31, 1919, and 33.28 per cent for the fiscal year ending March 31, 1920. The average price received per pound for the waste was 22.65 cents, 30.21 cents, and 30.38 cents in each of the fiscal years in question.
    The method of calculating waste and the percentage of waste as shown by the petitioner for the various years were accepted by the respondent at the hearing. Likewise, the petitioner conceded that the corrections which were made by the revenue agent in the raw cotton inventory on account of bales of cotton which had been opened but not yet put in process were correct.

      Petitioner included depreciation on tenement houses in administration expenses and claims that the Commissioner erred in including this depreciation in manufacturing costs. The Commissioner now admits that the rent received from these houses should be deducted from depreciation which he has included in manufacturing cost. Due to the slight difference between the parties on this point the petitioner accepts this adjustment and the parties are otherwise in accord as to manufacturing costs.
    The various items entering into the manufacturing costs (except the item for depreciation on tenement houses hereinbefore referred to) and the method by which cost of goods in process and cost of finished goods was determined, as shown by the petitioner were accepted by the respondent as being correct.
   OPINION.

Littleton :

The only question in' controversy in this case is the basis to be used in determining the cost per pound of raw cotton entering into the inventories of the petitioner for the taxable years ended March 31, 1918, and March 31, 1920.

Since the revenue agent who made the investigation failed to find inventory records from which it was possible to identify specific purchases of the goods on hand at the various inventory dates, he applied that part of article 1582, Regulations 62, under subdivision (a) with respect to intermingled goods, which is quoted below:

Goods taken In the inventory which have been so intermingled that they can not be identified with specific invoices will be deemed to be either (a) the goods most recently purchased or produced, and the cost thereof will be the actual cost of the goods purchased or produced during the period in which the quantity of goods in the inventory has been acquired, or * * *.

The petitioner takes exception to the use of this method on the ground that it is inequitable, in its case, to apply a method which is based on a presumption that the goods on hand are those most recently purchased when the facts rebut any such presumption, and maintains that an average cost based on acquisitions of raw cotton throughout each year and cost of raw cotton on hand at the beginning of each year, will furnish an inventory valuation with which its income can be more nearly reflected than that used by the Commissioner.

Section 203, Revenue Act of 1918, provides:

That whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.

It will thus be seen that section 203 provides two tests to which each inventory must conform: (1) It must conform as nearly as may be to the best accounting practice in the trade or business, and (2) it must clearly reflect the income.

The basis of valuation most commonly used by business concerns and which is accepted by good accounting authorities is: (a) Cost, or (b) cost or market, whichever is lower. Whether this taxpayer used the first or second basis is not definitely established in this case and is not material since cost was always lower than market and, therefore, for the purpose of our determination we need only consider whether cost has been used in the raw cotton valuation by either of the bases contended for.

First, we are of the opinion that the basis used by the Commissioner is erroneous for the reason that the presumption on which it is based is clearly rebutted by the evidence presented. In other words, we do not conceive that there is' any conclusive presumption that the goods on hand at a particular inventory date are those most recently purchased, but that such a rule is applied only as a rule of convenience where competent evidence to the contrary is not shown. To adopt it in this case would be to disregard the fact that it was the petitioner’s practice to use the last goods purchased first; that its storage facilities were such that it was impracticable to follow any practice other than the withdrawal of the later purchases first and further that in 1917 it changed from the manufacture of a product which required the use of a low grade of cotton to the manufacture of a product which required the use of a greater percentage of high-grade cotton, and, therefore, the tendency was to use more of the high-grade cotton which was being purchased rather than the low-grade cotton, a supply of which was on hand when the change was made. Since this method is not shown to represent cost and since the presumption on which it is based has been rebutted, it must be disregarded in this case.

Secondly, does the method contended for by the petitioner in its revised inventories represent a cost valuation? It is what might be termed an average cost valuation in which the opening inventory and purchase of raw cotton during the year are considered to arrive at a weighted arithmetical average for a unit cost which is applied to the poundage on hand to determine the cost valuation. While this method in this case takes into consideration more factors than that employed by the Commissioner, we are not convinced that &ie petitioner’s inventory so determined would be on a cost basis. Again this would seem to be another rule of convenience the application of which must be disregarded when a more nearly correct basis is available. For such a method to represent cost, so many factors, such as purchase, sale and use of cotton, must concur in such an ideal manner, which we consider highly improbable of- having happened in this case, that the basis can not be approved as representing a true cost valuation.

More merit would attach to the taxpayer’s method if we were dealing only with the fiscal year ended March 31,1918, on account of its change in its manufacturing process for that year, but even here we are faced with the difficulty that only the closing inventory has been adjusted, which is not only contrary to good accounting practice, but also contrary to the principle of consistency which we have laid down on numerous occasions. Appeal of Thomas Shoe Co., 1 B. T. A. 124; Appeal of George C. Peterson Co., 1 B. T. A. 690; Appeal of Buss Co., 2 B. T. A. 266, and other subsequent decisions.

Finally, we are of the opinion that it is unnecessary to resort to either of the above arbitrary bases when a basis which more nearly reflects cost is available. The petitioner showed that it keeps a perpetual inventory in the form of a cotton book, in which it lists each bale 'of cotton purchased with the number of the vendor and that of the petitioner, the actual weight, price per pound, and name of the vendor. When cotton is withdrawn for consumption, the bale used is checked off so that at the end of any period it would be possible to determine not only the number of pounds on hand, but also its actual cost. It would not be an average cost in any sense, but instead a true cost based on actual purchases of cotton not consumed, even if the cotton on hand had been purchased several years prior to the date on which the valuation is made.

The following testimony by petitioner’s 'bookkeeper which was given in answer to questions by petitioner’s counsel, shows the method which was followed in keeping this cotton book and determining the inventory therefrom:

Q. Mr. Gardiner, when cotton was purchased, what entries did you make on your mill hooks?
A. On my mill books I made the entries from whom I buy the cotton, the total amount of pounds, the dollars and cents. That goes on the journal. Then I have a cotton book that I take and put each and every bale separate, and put on the number. It may start at 695 and run up to 745, run up fifty numbers. It has their number on it and my number, and then I put the actual weight of the cotton in the cotton hook and the price, and where it is bought from.
Q. When you withdraw that cotton from the warehouse to be used, what entry do you then make on your cotton book?
A. I take it out on my cotton book as being used, with a check mark; I put on the pounds and the tag and also the price, and put them all together. In a month’s run, using maybe 275 bales, I have fifty bales of one price, five of another, a half dozen of another and so on. I sort them all out and get the different prices on the different piles and take an adding machine and run them up and multiply them by the prices paid for them and charge it out to cotton, consumed.'
Q. At the close of the year, when you made your inventory, you said that the cotton was stacked in the warehouse where you could not readily get to it. Did you check that against your cotton book as to the actual bales on hand?
A. I checked up the actual hales on my ledger.
Q. I mean the numbers of the bales.
A. No, I didn’t.
Q. How did you make up your inventory?
A. Whenever it was so I could not get at it to count the cotton and get the tags, I took the pounds on the left-hand side, the pounds and the dollars and cents it cost, and on the right-hand side the pounds and dollars and cents that had been consumed, and I took the difference and made an average price.
Q. That was the way you took it?
A. When I couldn’t count it.
Q. When you could count it?
A. When we co.uld count it, we did it exactly as we charged it out — run over and put the price on it and the pounds.
Q. Was that book kept during the fiscal years of 1918, 1919 and 1920?
A. Tes, sir.

The cost so. determined, barring inaccuracies, would not be an average price, as inaccurately referred to by the witness, but would be an actual cost. The physical count, to which he referred, is understood to be the physical inventory which was taken only at March 81, 1920, in so far as the years on appeal are concerned.

The petitioner offers objection to this method on the ground that its cotton book contains inaccuracies in that tags are lost off the bales and, therefore, it is not possible to identify such specific bales used, and that tags are not always returned by the employees when the cotton is withdrawn and, therefore, no entry can be made in the cotton book. Again, we- fail to see where the method advocated by the petitioner would serve to correct either of these errors, as in both methods the number of pounds would be excessive by the same amount. Errors of both types would be corrected when a physical inventory is taken, but we do not have a physical inventory, except at the close of 1920, and, therefore, we must depend on the most reliable information available which seems to be the perpetual inventories maintained. These inventories are undoubtedly faulty, but they at least represent an attempt to arrive at a cost valuation, and, the percentage of- error is small when we consider that from April 1,1917, to March 31,1920 — the latter date being the only time within the three years when a check was made of the cotton book with the physical inventory — a difference of approximately 100 bales was found when a physical inventory was taken and in that period approximately 6,000 bales were consumed, or a percentage of error of only 1.67 per cent. The following testimony by petitioner’s bookkeeper on cross examination by respondent’s counsel further indicates the accuracy of petitioner’s cotton book:

Q. The only time where yon do not take the actual tag and the actual price is where the tag may be ripped off?
A. Where the tag is ripped off and we cannot get to them.
Q. Do you find any such discrepancy between the actual inventory and the book inventory as 48,000 pounds in any one year now ?
A. Not in any one year. There may be over a period of years. We find a discrepancy every year between what we ought to have and what we have in the records.
Q. There is no such discrepancy in any one year now, is there?
A. No, not in any one year. What you have reference to might run over a couple of years. I don’t know.
Mr. Littleton. When you can’t find the tags, can you tell by the position of the bale when it was probably purchased?
The Witness. No, sir. We have no record of it. We just take what we have left and make up our stock accounts.
Mr. Littleton. You keep a record as you purchase cotton?
The Witness. Oh, yes.
Mr. Littleton. Then when you check the bales that have tags on them, you can check that against the bales that have no tags?
The Witness. When we get bales that are short, we are short just that much. That will go in the year’s production.
By Mr. Allen.
Q. That doesn’t happen to many bales now, does it?
A. Not to very many bales lately. But we have it to happen to a few bales every year.

We, therefore, are of the opinion that the petitioner’s raw cotton inventories, for the years on appeal, should be valued by the use of the perpetual inventories which it maintains. Correction should, of course, be made on account of the difference in poundage found by the revenue agent and on account of the arbitrary reduction in value at March 31, 1918. Similarly, adjustment should be made to the physical inventory at March 31, 1920, where a difference of approximately 48,500 pounds is shown. We are of the opinion that a reasonably accurate method of adjusting this difference would be to consider that to this extent cotton was not properly recorded when withdrawn over the three-year period from April 1, 1917, to March 31, 1920, and reduce the closing inventories of each of the years on the basis of the poundage consumed in each year, pricing the cotton entering therein on the basis of the average cost for the respective grades during each of those years.

This method would seem to be substantially in conformity with the alternative method suggested in article 1582, Regulations 62, which was improperly disregarded by the revenue agent and which réads as follows:

* * * Or (b) where the taxpayer maintains book inventories in accordance with a sound accounting system in which the respective inventory accounts are charged with the actual cost of the goods purchased or produced and credited with the value of goods used, transferred, or sold, calculated upon the basis of the actual cost of the goods acquired during the taxable year (including the inventory at the beginning of the year) the net value as shown by such inventory accounts will be deemed to be the cost of the goods on hand.

As to the method which the petitioner used in determining the cost of cotton consumed, we have the following testimony from the petitioner’s bookkeeper:

Q. In arriving at the cost of cotton consumed, would you take it by the actual cotton or the average cost?
A. Take it by the actual price in pounds.
Q. Would that represent the actual cotton that went in, or your estimate of it?
A. The actual cotton that went in. We have the cotton tag, and we take the number on it and the weight, and when the card comes back I put the weight on it and the price.

In this manner, the petitioner has a fairly accurate record of the cost of cotton which enters into consumption, barring the inaccuracies which we referred to under the raw cotton inventory. The petitioner showed further that the manufacture of cotton is a continuous process in which the cotton is placed in process and continues until the finished goods are obtained. We would not have the situation of goods in process on hand at an inventory date which had been placed in process several months or years prior thereto, but it would only be recently placed in process. We are, therefore, of the opinion that a reasonably accurate method of valuing the raw cotton which entered into such goods would be on the basis of the cost of raw cotton most recently placed in consumption prior to the respective inventory dates, sufficient to equal the poundage in such inventory.

With respect to finished goods, we find that the total poundage on hand at each inventory date is very small as compared with the total production or total sales, representing in one instance less than one per cent of the total sales in pounds for the preceding twelve months. This would indicate that yarn is being produced as it is sold and that there is not on hand an appreciable accumulation which had been produced from cotton put in process long before the various inventory dates. We are, therefore, of the opinion that the same method should be followed in valuing raw cotton entering into finished goods as goods in process, viz., use the cost of raw cotton most recently placed in process prior to the various inventory dates sufficient to equal the total poundage in the finished goods inventory.

A redetermination should, therefore, be made in accordance with the foregoing, taking into consideration the adjustments with respect to waste, depreciation of tenements, and the various items entering into manufacturing costs on which both parties are agreed.

Judgment will be entered on SO days’ notice, wider Buie 60.


text:
    San Angelo Telephone Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8265.
    Promulgated April 30, 1927.
    The Board will not pass on whether one feature which might enter into petitioner's computation of depreciation has been incorrectly determined by the Commissioner when full information is not available to show whether the depreciation as allowed or claimed is reasonable.

      Alfred L. Geiger, Esq., for the petitioner.

      M. N. Fisher, Esq., for the respondent.
    This proceeding is for the redetermination of a deficiency of $2,400.63 for the calendar year 1920.
    The error alleged by the petitioner is that the Commissioner refused to allow the restoration, for depreciation purposes, of $78,371.06, which represented cost of capital assets shown by its books in 1913, but which had been erroneously written off in that year.
    FINDINGS OF FACT.
    The petitioner is a corporation organized under the laws of Texas with its principal office at San Angelo, and is a continuation of a business which was begun prior to 1905.
    Effective January 1, 1913, the Interstate Commerce Commission established a uniform system of accounts for telephone companies.
    At this time, the petitioner’s books of account showed a total in its Construction Account of $239,126.37, which was made up of various amounts, beginning with an estimated figure of $75,000 in 1905 and being increased from time to time by charges to this account. In complying with the order of the Commission the auditor of the petitioner computed what he considered the accrued depreciation to 1913 by the use of a 7 per cent rate which he applied by the reducing-balance method to the Construction Account. In setting up the new system of accounts, the auditor deducted the accrued depreciation which he had determined — $78,371.06—from the total construction account, leaving a balance of $160,755.31, which amount was used in setting up the balance sheet of the petitioner as of December 31,1913.
   OPINION.

Littleton :

The petitioner seeks to have $78,371.06 restored to the fixed asset account for depreciation purposes on the ground that the reduction by the auditor was an accounting error and that it should be allowed to use what its books purport to show as the cost of its depreciable assets as a basis for computing depreciation at the rate allowed by the Commissioner.

No provision is made in the Revenue Act of 1918 for a particular method of computing depreciation, the statute merely stating:

Sec. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
*******
(7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.

The proper allowance for such exhaustion, wear and tear is stated in article 161, Regulations 69 as follows (applicable to the years on appeal since the Revenue Act of 1918 is identical with the Revenue Act of 1926 on this point):

A reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used in the trade or business may be deducted from gross income. For convenience such an allowance will usually be referred to as depreciation, excluding from the term any idea of a mere reduction in market value not resulting from exhaustion, wear and tear, or obsolescence. The proper allowance for such depreciation of any property used in the trade or business is that amount which should be set aside for the taxable year in accordance with a reasonably consistent plan (not necessarily at a uniform rate), whereby the aggregate of the amounts so set aside, plus the' salvage value, will, at the end of the useful life of the property in the business, equal the basis of the property determined in accordance with section 204 and articles 1591-1603. Due regard must also be given to expenditures for current upkeep.

The above instructions seem to us sound and as showing that no particular method need be followed to arrive at the proper deduction under this provision of the statute. It is only necessary that the allowance as deducted be “reasonable.”

We are not asked by the petitioner to say that the depreciation as allowed by the Commissioner is not reasonable, but rather to permit the correction of one of the factors which enters into its method of computing the allowance. In other words, the petitioner has apparently followed the plan of computing depreciation at the rate of 7 per cent and now says that, because of the deduction made from its fixed asset account on account of accrued depreciation when it adopted the uniform system of accounts as prescribed by the Interstate Commerce Commission, it is thereby being deprived of a part’ of its cost as a basis for depreciation. Certainly, if 7 per cent is the proper rate for its depreciation on cost, and if $239,126.37 as shown in its Construction Account represents the cost of depreciable assets which are on hand and in use, depreciation computed at the same rate on the latter amount after it had been reduced by accrued depreciation for eight years would not give the correct result.

There is no evidence before the Board to the effect that 7 per cent when applied to cost would result in a reasonable allowance for depreciation, the only evidence being that 7 per cent was applied to a certain asset account, which the Commissioner does not concede as representing cost. And even if 7 per cent is the correct rate on a cost basis, the evidence is far from conclusive that the Construction Account represents cost of depreciable assets. We notice particularly that the first charge to this account is $75,000, which is an estimated figure set up on the books after the business had been in operation several years.

When the Board is without information as to what is the correct rate of depreciation, based on the useful life of the assets, and what is the cost and date of acquisition of the depreciable assets on hand and in use, or of the March 1, 1913, value, it is not in a position to say that the deduction allowed by the Commissioner for exhaustion, wear and tear is incorrect. These and other important features would necessarily enter into the determination of a reasonable allowance under section 234(a) (7) of the statute, and since we are without them we are unable to determine what amount constitutes a reasonable allowance for depreciation.

Judgment will be entered for the resfondent.


author: TRUSsell ;

text:
    Batson-Cook Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5458.
    Promulgated April 30, 1927.
    Bad Debts. — Certain accounts receivable ascertained to be ■worthless and charged off within the taxable year allowed as a deduction from gross income; certain other accounts claimed by the petitioner disallowed.

      Ernest T. Clayton, C. P. A., for the petitioner.

      J. L. Deveney, Esq., for the respondent.
   TRUSsell ;

This proceeding is for the redetermination of a deficiency in income and profits taxes in the amount of $2,846.98 for the calendar year 1919.

The petitioner alleges that the Commissioner erred (1) in disallowing $6,064.69 of the amount of $6,732.77 claimed as a deduction for bad debts ascertained to be worthless and charged off during 1919, and (2) in adding to income for the year 1919 an amount charged off as a bad debt prior to that year and recovered during that year, but which amount had already been included in petitioner’s return for 1919.

The general manager of the petitioner testified that its sales, which were mostly to farmers, amounted to over $500,000 during the year 1919; that after the charge-off of bad debts there remained on the books open accounts receivable in the amount of approximately $100,000; that the policy of the petitioner was to charge off each year debts which after careful investigation of the financial status of each debtor, of his crops and the returns therefrom, of the mortgages and liens on the farms and crops, and after consultations with bankers, were ascertained to be worthless and uncollectible; and that if, in any subsequent year any collections were made on such debts, the amounts so collected were treated as income in the year received.

No evidence has been adduced to sustain the petitioner’s second allegation of error.

FINDINGS OP PACT.

The Batson-Cook Co. is a Georgia corporation with its principal place of business at West Point. Since its incorporation, and during the taxable year 1919, the petitioner has been engaged in the business of selling building supplies and of general contracting. Most of its business has been with farmers, of the surrounding territory, on credit and usually payment depended upon the success of the crops. The petitioner’s general manager used his own business judgment in extending credit, and exercised due diligence and care in ascertaining debts to be worthless.

During the period from January 1 to March 15, 1919, the petitioner kept a ledger account under the heading of bad and doubtful accounts, and during that period 21 accounts were entered therein aggregating $218.53. At the end of the year these accounts with this total were transferred and charged to profit and loss. During the period from March 15 to November, 1919, petitioner from time to time charged to profit and loss 16 other accounts ascertained to be worthless, aggregating $439.70. In December, prior to the closing of the books for the' year, petitioner ascertained to be worthless and charged to profit and loss another group of accounts aggregating $2,570.35. The sum of these three items is $3,228.58.

In making its income-tax return for the year 1919, the petitioner claimed as a bad debt deduction another group of accounts aggregating $3,504.19. This item was entered upon petitioner’s books as a charge against surplus under date of January 1, 1920.

The allowable deduction from gross income on account of debts ascertained to be worthless and charged off during the year is $3,228.58.

The deficiency will be redetermined in accordance with the foregoing findings of fact on 15 days' notice, pursuant to Rule 50. Judgment will be entered accordingly.


author: Morris:

text:
    Aluminum Flake Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 4669, 8444.
    Promulgated April 30, 1927.
    The value for invested capital purposes of a.clay deposit paid,in for stock in 1903 determined.

      Herbert D. Gohen, Esq., for the petitioner. • .

      Shelby S. Faulkner, Esq., for the respondent.
    These proceedings are for the redetermination of deficiencies in income and profits taxes for the fiscal years ended May 31,1918,1919, and 1920, in the amounts of $3,850.65, $1,608.84, and $4,049.28, respectively. The sole issue presented is the value for invested capital purposes of property paid in for stock.
    BINDINGS OB BACT.
    The petitioner is a Maine corporation organized May 25, 1903, as the American Kaolin Co., its principal office -being located at Akron, Ohio. On June 7, 1905, the name was changed to the Aluminum Flake Co. The authorized capital stock when incorporated was 5,000 shares, par -value $100 per share.
    For several years prior to 1903, Frank Reifsnider had been experimenting with clay taken from a large deposit found on his property. The pi'operty was located near Warrenton, Mo., and consisted of approximately 807 acres, of which Reifsnider owned approximately 415 acres and held the balance under lease. Reifsnider had formerly been superintendent of a rubber manufacturing concern and made a number of experiments which proved that this particular clay could be used in the manufacture of rubber goods and in paints He perfected certain machinery which would pulverize the clay so that the same could be used for this and other purposes.
    The deposit of clay had been examined by a number of geologists and clay experts and numerous samples had been chemically analyzed. The examination disclosed some seventeen pits and, outcroppings of the clay deposits and at least one of the pits had been worked since 1885 without being exhausted. A number of estimates had been made as to the tonnage of clay available, the minimum estimate being 170,000 tons, while the largest was in excess of 2,000,000 tons. One of the examinations was conducted by the Missouri State Geological Survey during the years from 1890 to 1895, and in their report- of the survey the quantity of clay in this deposit was estimated to bo in excess of 2,000,000 tons. The analyses prqved that the deposit was of exceptionally high-grade flint clay, and the experiments conducted by Reifsnider developed additional uses for the clay which up to this time had been principally used for fire brick. The official report of the Missouri State Geological Survey imblished in 1900 stated that the Reifsnider deposit was “ one of the most remarkable clay deposits in the known world. * * * It consists of several hundred acres of Lorraine Shales, in place, altered into a fine white plastic claj'-, suitable for almost any ceramic purpose. The original shale bed was about 60 feet thick and had an exposed area of 500 or 600 acres. The supply is, therefore, practically inexhaustible.”
    The directors of the corporation in 1903 were William H. Hoover, Frank Reifsnider, Charles Reifsnider, Nathaniel P. Goodhue, and William E. Young. Frank Reifsnider offered to convey to the corporation his property and leaseholds containing the clay deposits in consideration for $400,000 of the capital stock of the corporation. This offer was accepted by the directors of the corporation and a transfer made. At the same meeting at which the directors authorized the purchase of the Reifsnider property with capital stock of the corporation, which was held on May 28,1903, the directors authorized the sale of $50,000 of the capital stock at $33,331/8 per share. Within the year, the directors authorized the sale of a smaller block of stock at $50 per share. The proceeds of these sales were used in developing the clay deposit near Warrenton, and establishing and equipping a plant at Akron, Ohio.
    The raw clay in the Reifsnider deposit was mined and loaded on railway cars at the deposit, which had a spur track connecting with the railroad. The clay was then shipped to Akron where it was cleaned and brushed, and after being milled, was sacked for sale. Reifsnider, before incorporating the American Kaolin Co., had ascertained that manufacturers of rubber goods could use this particular clay, and that they would pay $20 to $30 per ton for the same f. o. b. Akron. In 1903 the sacked clay was selling for $35 per ton, while the clay dust, a by-product, brought $40 to $50 per ton. The raw clay could be mined for from 50 cents to $1 per ton, depending on the length of the haul from the pit to the car. The raw clay was selling for $1.50 to $2.50 per ton f. o. b. shipping point. Farmers in the community mined the raw clay at irregular intervals from other good deposits located in the same vicinity. The quantity of clay mined by the farmers was contingent upon the condition of their crops and the roads over which they had to haul the clay to the cars. Olay brought in by the farmers was purchased by the petitioner and other interests using the same.
    The following table shows the quantities of clay sold by the petitioner from September 1, 1903, through May 31, 1919:
    Tons.
    Sept. 1, 1903, to May 31, 1904_ 35
    Tear ended May 31, 1905- 83
    Tear ended May 81, 1906- 304

      Tons.
    Tear ended May 31, 1907_ 669
    Tear ended May 31, 1908- 351
    Tear ended May 31, 1909_ 633
    Tear ended May 31, 1910_ 775
    Tear ended May 31, 1911_ 826
    Tear ended May 31, 1912_ 1,195
    Tear ended May 31, 1913_ 1,543
    Tear ended May 31, 1914_ 1, 539
    Tear ended May 31, 1915_ 1, 281
    Tear ended May 31, 1916__:_ 2, 622
    Tear ended May 31, 1917_•_2, 527
    Tear ended May 31, 1918- 3,169
    Tear ended May 31, 1919- 2,801
    Total___ 20,253
    Of the foregoing total only 3,576 tons were mined from the Company’s deposit, the balance either having been purchased, or obtained from the leases. For the last few years practically no clay had been obtained from the leases, all of it being purchased from producers in the surrounding territory. However, the leases are still in effect and the Company may at any time obtain clay from them.
    On September 23,1914, the petitioner amended its by-laws whereby capital stock was arbitrarily reduced from $500,000 to $50,000. On October 5, 1914, entries were made in the books to reflect this adjustment, and real estate was reduced from the $400,000 value at which the deposit had been carried to $15,000. Thereafter, on July 22, 1918, the directors arbitrarily increased the capital stock by adding $100,000 to the then book value of its clay deposit.
    The value of the property acquired for stock in 1903 was at least $138,840. The respondent valued the property at $15,000 in computing invested capital.
   OPINION.

Morris:

The issue raised is the value to be used, in computing invested capital, of the Reifsnider property which was paid in for $400,000 of the capital stock of the petitioner. In support of its valuation the petitioner offered evidence of the sale of certain shares of stock at or about the same time the property was acquired for $33.33% per share and $50 per share. The petitioner also offered the testimony of two of its original incorporators and various corporate officials, and the expert testimony of a consulting engineer and geologist. .The respondent relies upon the valuation made by the board of directors in 1914, when capital stock was reduced from $500,000 to $50,000, and the property was valued on taxpayer’s books at $15,000.

The rule of law seems to be well settled that the valuation of property placed thereon by the board of directors in the exercise of their best judgment is evidence of actual value, but where the directors have arbitrarily placed successive valuations upon the property, the probative weight of any one of the values so fixed is lessened by each additional valuation. In the instant proceeding the board of directors have placed three separate values on the property as shown by their books. Any one of the values so fixed carries no greater weight than the other two so that if we would fix the value of the property, we must look to evidence other than the determination of the board of directors.

The best evidence of value adduced was the expert testimony of H. A. Wheeler, a consulting engineer and geologist. Wheeler was a graduate mining engineer with some 40 or more years of experience. He was with the United States Geological Survey; he was an organizer and the first president of the American Ceramic Society; he has been a manufacturer in the clay industry for many years; he has been professor of geology and mining at Washington University, St. Louis, Mo., for 12 years, and he was engaged by the State of Missouri to work up the clay resources of that State with the State Geological Survey. In the latter work he visited during 1890 to 1895 the clay deposits of Missouri, examining and analyzing the deposits and samples of the clay. He testified that the Reifsnider deposit was “ the richest and most extensive of the flint clay deposits known at that time,” that the tonnage of clay available was approximately 200,000 tons, that the clay in place was worth at least $1 a ton, and that land as rich in clay as the Reifsnider property was conservatively worth $200 per acre. He further testified that he had intended acquiring the Reifsnider property but was unable to do so because of a lack of capital. Also that the railroad connections which the Reifsnider properties had made the clay deposit much more valuable than the same property would be without such transportation facilities.

The petitioner is here alleging that this property should be valued at $138,840 in 1903. The evidence of the officers and directors and the expert testimony points conclusively to the fact that this value should be allowed. We are of the opinion, therefore, that the petitioner has sustained its allegations and that in computing invested capital the property paid for stock should be valued as claimed.

Judgment will be entered for the petitioner on 15 days notice, under Bule 50,


author: MoRRis:

text:
    Appeal of Oul Building & Loan Association.
    Docket No. 3865.
    Promulgated April 30, 1927.
    Tlie petitioner is exempt from taxation, under section 231 (4) of the Revenue Acts of 1918 and 1921 for the years 1918 to 1922, inclusive.

      John J. BabTca, Esq., for the petitioner.

      J. ArtTmr Adams, Esq., for the Commissioner.
    The petitioner appeals from the Commissioner’s determination of a deficiency of $2,608.32 for the years 1918 to 1922, inclusive. The deficiency results from the refusal to allaw petitioner’s claim for exemption under 'section 231 (4) of the Revenue Acts of 1918 and 1921. The petitioner alleges that the total deficiency for the five years amounts to $16,840.30.
    FINDINGS OF FACT.
    The petitioner is an Ohio corporation located in Cleveland, having been incorporated under section 9643 of the General Code of Ohio on December 2,1915. The company was incorporated with a capital stock of $1,000,000 consisting of 5,000 shares of $200 each.
    The constitution states the purpose of incorporating as follows:
    ARTICLE II.

      Purpose

    This Association is organized for the purpose of raising money to be loaned among its members and depositors and others on such terms, conditions and securities as may be provided by the By-laws and generally tire doing of all things and the transacting of all business authorized by the laws of Ohio to be done and transacted by Building and Loan Associations.
    The petitioner received funds from stockholders and nonstock-holders. Deposits on hand for period of more than 30 days were paid or credited with interest at the rate of 5 per cent per annum. The source of deposits received by the petitioner during the years in question was as follows:

    The funds deposited, interest paid or credited thereon, and the deposits withdrawn as of December 31, are shown for each of the years in the following table:

      When depositors made withdrawals they were required to do so in person and to present their pass books in which the amount withdrawn was entered. This was true regardless of whether the depositor was a member of the association or not. The petitioner then drew a check on its depository for the amount withdrawn in favor of the withdrawing depositor. The association had no checking accounts.
    The petitioner borrowed and repaid funds as follows during the taxable years in question:

    The petitioner secured funds to loan to members by the sale of its running or installment stock. The shares had a par value of $200 and the subscriber paid 50 cents per week on each share. The receipts from these payments, plus dividends, less withdrawals, leaving a credit balance as of December 31, is shown by the next table:

    The paid-up capital stock, the total number of nonborrowing stockholders, and the amonnt of stock they held, the number of borrowing stockholders and the total number of stockholders, follow:

    The petitioner made loans to members on mortgage security or on pass book or stock security. Loans were made only to members owning one or more shares of stock of the corporation which qualification for membership was provided for in the by-laws. Loans on mortgage security were all made to members owning running stock with one exception; one stockholder owning paid-up stock secured a loan. From 1918 to 1922, inclusive, the 698 members securing loans owned stock on the following bases:

    A recapitulation of the loans on mortgages for the five years shows that individuals, partnerships, and corporations secured loans as follows : 9 loans for business block development; 29 loans to purchase or construct dwellings; 6 loans for the purchase of land or lots; 1 loan for allotment purchases; 1 loan to purchase an apartment; and 652 loans to purchase, construct or refinance homes. The parties stipulated that loans on “ homes ” meant loans to shareholders in connection with real estate not primarily for rent or sale; and that loans on “dwellings” meant loans to shareholders on real estate primarily for rent or sale.
    Interest charged stockholders on mortgage loans ranged from 6 per cent to 8 per cent. Original loans were practically all made at interest rates of T per cent and 7y2 per cent. One loan was made at 8 per cent, three loans at 6 per cent, and seven at 6y2 per cent, and the balance at 7 per cent and 7% per cent. After the loan became less than 50 per cent of the mortgage security, and if the installments had been promptly met, it was a policy of the association to reduce the interest rate by % per cent to 1 per cent. Approximately 29 per cent of the loans were reduced during the five-year period. Interest charged on loans on pass-book or stock security was 6 per cent per annum. From 1918 to 1922, inclusive, 349 loans were made on pass-book or stock security.
    The loans obtained by members were of two kinds, viz., straight loans and installment loans. Straight loans matured at one time in their entirety, and were made on real estate not “ in excess of 50 per cent of the appraised value thereof, unless such loan shall mature within three years from date.” (Sec. 24, by-laws.) Installment loans were payable by weekly or monthly installments.' The loans could not “ exceed two-thirds of the appraised value of the security offered,” and were subject to certain terms and conditions contained in the contract. (Sec. 25, by-laws.) Loans were also made on pledged stock of the association. On such loans members could borrow within five dollars of the amount which they had paid in to the association on their stock.

      Loans made, receipts on mortgage loans, yearly increase, and total loans receivable on the thirty-first of December for each year are as follows:

    From time to time funds were received by petitioner from payments or transactions which constituted credits to mortgages. Such credits were applied to the loan account only after a certain sum had accumulated with respect to each loan. The amounts credited during each year, amount applied on loan accounts, yearly increase, and total credits unapplied to mortgage loans on December 31 follow:

    The petitioner paid or credited stockholders with dividends at the rate of 8 per cent for 1918, 1919, and 1920; 9 per cent for 1921; and 7y2 per cent for 1922. The by-laws of the association contain the following section as to dividends:

      Dividends

    Sec. 14. The Board of Directors shall, on the second Wednesday in January and July of each year, declare such dividends as it may determine from the earnings of the Association after deducting from said earnings all expenses and interest and also such sum as it may reserve for the fund for the payment of contingent losses and any balance of said earnings thereafter remaining, it shall carry into the Undivided Profit Fund, which Fund shall be subject to such purposes and uses as the Board of Directors may lawfully direct, provided that the total Undivided Profit Fund shall at no time exceed three per cent of the assets.

      The dividend so declared shall he divided among ail members in proportion to the amount paid in by each member as duesi on his stoelc. The amount paid in at the time the preceding dividend was declared, unless the same has been since withdrawn, shall be the basis of calculation.
    The dividends declared shall be credited on the pass books of depositing members in January and July of each year, and holders of certificates of paid-up stock shall be entitled to receive the dividends in cash at the office of the Association within ten days after the same have been declared. (Italics ours.)
    The undivided profits were increased at the end of each year as follows:
    December 31, 1917_ $993.11
    December. 31, 1918- 3, 825.36
    December 31, 1919- 5,408.71
    December 31, 1920_ 8,823.57
    December 31, 1921_ 10, 248. 69
    December 31, 1922- 18,249. 73
    The income, deductions, and distribution of net income for each of the years 1918 to 1922, inclusive, are as follows:

    The balance sheet of the petitioner at the end of each of the years 1918 to 1922, inclusive, is as follows:

   OPINION.

MoRRis:

The petitioner alleges its exemption from tax under .section 231 (4) of the Revenue Acts of 1918 and 1921. Section 231 (4) of the 1918 Act provides:

That the following organizations shall be exempt from taxation under this title — - * * * (4) - Domestic building and loan associations and cooperative banks without capital stock organized and operated for mutual purposes and without profit.

Section 231 (4) of the 1921 Act states the exemption as follows:

That the following organizations shall be exempt from taxation under this title— * * * (4) Domestic building and loan associations substantially all the business of which is confined to making loans to members * * *.

The Commissioner contends that the petitioner lacks several of the essential characteristics of the legitimate building and loan association, namely, mutuality, and the accumulation of funds primarily for making loans to members for the purpose of building or acquiring homes, that the business resulted in large profit to those who neither borrowed nor furnished the capital used in the business of the taxpayer; that the profits accrued to the benefit of a small group precisely as in the case of an ordinary corporation trading in money or merchandise, and that petitioner is therefore in the same class with corporations which operate a financial business for the benefit of their shareholders and should stand in no better position for the purpose of Federal taxation than similar institutions.

We have previously, in an extended opinion, considered the nature of building and loan associations and reviewed the Federal court decisions pertaining thereto.' Appeal of Johnstown Building & Loan Association, 6 B. T. A. 463. We could rest the decision in this proceeding (that the petitioner comes within the provisions of section 231 (4) of the Revenue Acts of 1918 and 1921) on the ruling therein made that that organization was exempt for the year 1922, although taxable for the prior years, the sole distinction being that for said year all of its loans except two were made to members. Such, disposition, however, is not consonant with the importance of the question involved. In view of that opinion we deem it unnecessary to retrace the field therein covered, and therefore merely restate some of the principles to be drawn from it and the cases therein cited.

All the authorities agree that the distinguishing characteristic of building and loan associations is the substantial mutuality of benefit existing between the members. Such mutuality implies that borrowing members and lending members participate in earnings on a fairly equal basis or members share in the profits on substantially the same footing. Mutuality is not destroyed by the issuance of prepaid shares upon which there may be an inequality in the returns to the prepaying shareholder and the other shareholder in favor of one or the other. The borrowing of money by a building and loan association in the furthering of the purpose of its organization does not of itself change the character of the organization, nor destroy the mutuality between the members. Exemption to a true building and loan association can not be denied because it does not require each borrowing member to subscribe for an amount of stock equal to the face of his loan. Any association which maintains the requisite mutuality is entitled to exemption entirely without regard to the amount of stock subscribed by its borrowing members. Congress in all of the acts, from 1909 to 1921, has granted an exemption from income and profits taxation only to those associations organized for mutual benefit or mutual purposes. Some measure of departure like the borrowing of funds from nonmembers or the making of loans to nonmembers when done merely as an incident to the general purpose of the organization does not defeat the exemption. When an organization, however, departs from the general purposes of a building and loan association and enters the field commonly occupied by savings banks and mortgage loan companies, said organization is no longer operated along the lines peculiar to building and loan associations.

Viewing the facts in the instant case in the light of the above principles we reach the conclusion that the petitioner is exempt from taxation for the years in question. The petitioner is operated for mutual purposes in that all the members share equally in the profits of the association to the extent of their stock. Loans were made exclusively to members and although not all for the purpose of building and acquiring homes, the loans for other purposes were few when compared with the bulk of the business and merely incidental. The loans were not all made on the basis of the borrowers’ stock-holdings, but exemption can not be denied on that ground.

The reason for our conclusion is further clarified when the facts are compared with those of the Johnstown Building & Loan Association, supra, for the years 1919 to 1921 inclusive, in which we disallowed the exemption claimed, and Lilley Building & Loan Co. v. Miller, 280 Fed. 148, in which the United States District Court denied exemption and was sustained by the Circuit Court of Appeals, 285 Fed. 1020. In each of the above cases most of the business was conducted with nonmembers. In the instant case, outside of the money obtained from depositors who were nonmembers, all of the business of the association was done with members. Deposits by nonmembers over the five-year period averaged 32.17 per cent of the total deposits. Comparing the facts pertaining to the year 1920 in this and the Lilley case we find that the Lilley Company had 301 stockholders, two of whom, out of a total of 495, were borrowers; the petitioner had 2,310 stockholders, 373 of whom were borrowers, all borrowers being stockholders. The Lilley Company had 2,239 savings depositors; the petitioner 1,254 depositors, 927 of whom were stockholders. In the LAlley case, paid-up stock exceeded the running or installment stock while in the instant case the paid-up stock is less than one-tenth of the installment stock in amount.

In the Johmtown case the association did most of its business with nonmembers during the years 1919, 1920, and 1921, most of its loans and deposits being made to and received from nonstockholders. Its paid-up stock was greatly in excess of that of the petitioner while its running stock was substantially less.

The consideration of the above facts in the Lilley and JoJmstoum cases clearly distinguishes those cases from the instant proceeding. The factors determinative of the denial of exemption in those cases are the strongest links in support of the petitioner’s exemption.

Judgment will be entered for the fetitioner on 15 days' notice, under Bule 50.