text:
    Elba Manufacturing Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.

      Docket No. 6995.
    Promulgated February 7, 1927.
    The Commissioner’s determination of the petitioner’s invested capital for the taxable years was erroneous for the reason that he incorrectly computed its depreciation reserve.

      E. S. Parker, Esq., and J. L. Elliott, G. P. A., for the petitioner.

      A. H. Fast, Esq., for the respondent.
    The Commissioner determined deficiencies of $11,008.44 and $2,741.17 for the fiscal years ending August 31, 1919 and 1920, respectively. The petitioner questions the correctness of only $9,138 in the total tax of $13,749.61. Petitioner claims that the Commissioner erred in reducing invested capital on account of his determination of the alleged depreciation of plant and equipment sustained from 1904 to August 31, 1918. The position of the petitioner is that its correct depreciation reserve for this period was $88,528.47.
    FINDINGS OF FACT.
    Petitioner is a North Carolina corporation engaged in the manufacture of cotton-seed oil at Charlotte. At the date of organization in April, 1904, petitioner had a paid-in capital of $68,600 and that amount of stock outstanding. It carried on active manufacturing operations during only eight months of each of its fiscal years. Its business was seasonal and depended entirely upon the harvesting of the cotton crop. During the four-month period of inactivity in each year petitioner made numerous repairs, replacements, and additions to its plant and equipment so as to be ready for the ensuing year’s operations. From the date of incorporation until dissolution in 1925 petitioner kept its plant in a very high state of efficiency. Each year the machinery and equipment were carefully inspected and overhauled, and repaired or replaced so that the ensuing eight-month period of operations could be carried on without interruption or inefficient operation of the equipment. Frequently certain of the stockholders and some of the officers complained that too much money was being expended annually for repairs and replacements, but the president of the corporation would not consider any change in his policy of starting the period of operation with all machinery and equipment in perfect condition.
    Little consideration was given to the matter of formal bookkeeping. The stock of the corporation was held by a small group of persons who were familiar and in close touch with the affairs and the business of the corporation. Prior to the fiscal year ending August 31, 1919, the corporation never charged any depreciation ’ upon its books of account, nor did it carry upon its books a strictly depreciation reserve account. From the 'date of incorporation to 1919 the petitioner carried upon its books an account styled “ Reserve for Depreciation,” which was a general balance account into which the difference between the assets and liabilities at the end of the year was carried. The company carried no profit and loss or surplus accounts as such upon its books. The account styled “ Depreciation Reserve ” represented profit and loss, surplus, and reserve for depreciation combined. The net earnings for the year were added to this account, losses sustained were charged against it, and stock and cash dividends were paid out of it. The amount shown in the “ Reserve for Depreciation ” account in any year was never regarded by the corporation or the banks from which it borrowed considerable sums of money from time to time as strictly a depreciation reserve. Prior to the excess-profits tax the corporation never considered it necessary to maintain upon its books separately profit and loss, surplus, or reserve for depreciation accounts. In 1919, when the • petitioner’s attention was called to the fact that these accounts should be kept separately, it had its books rewritten so as to reflect correctly the true situation. The profits and losses for the fiscal years ending August 31, 1905, to and including August 31, 1918, after taking into consideration all items of expense but with no reduction for exhaustion, wear and tear, were as follows:

      The “ Reserve for Depreciation ” account carried upon petitioner’s boohs was increased or decreased according to the profits or losses as reflected by the difference in its assets and liabilities as disclosed by its balance sheet at the end of each fiscal year. At the beginning of the fiscal year 1910 this “ Reserve for Depreciation ” account showed a balance of $72,000, and at the end of that year it showed a balance of $106,330. During the fiscal year 1910 a 155 per cent stock dividend was declared and paid, which wiped out the amount shown in the “ Depreciation Reserve ” account. At the same time $65,100 par value of the common stock and an undisclosed number of shares of preferred stock, were sold for cash at par, which made the common stock of the corporation _ at the beginning of the fiscal year 1911, $240,000, par value.
    At the beginning of the fiscal year 1911 there was no balance in the “ Reserve for Depreciation ” account, but during the subsequent years additional amounts were carried into the account so that at the beginning of the fiscal year on September 1, 1917, the account showed a balance of $138,234.22. Out of this amount dividends amounting to $115,680.65 were paid, leaving only $23,553.57 in the “ Reserve for Depreciation ” account.
    In 1923 the Commissioner’s field agent made an investigation of the petitioner’s books of account and, upon finding that it had kept its books as above indicated, he went back for the purpose of determining the reserve for depreciation, in the computation of invested capital, to the fiscal year 'beginning September 1, 1910, and started with the balance of $72,000 shown in the “ Reserve for Depreciation ” account, which included profit and loss, surplus and depreciation, as a total reserve for depreciation, and then proceeded to build up a depreciation reserve for years subsequent to 1910 at rates which the petitioner does not dispute. The agent gave no consideration to depreciation for years prior to 1910 or to the cost of any additions and replacements. By this method the agent computed a depreciation reserve of $138,234.42 at August 31, 1917, and of $156,835.61 at August 31, 1918. As a result of this determination he held that dividends of $115,680.65 for years prior to the taxable years here in question were paid out of capital and reduced invested capital accordingly. The depreciation reserve computed to 1910 upon petitioner’s plant and equipment without regard to additions and replacements, at the rates used by the Commissioner, would have been $32,802.54 instead of $72,000 as used by the agent. Petitioner did not consider the revenue agent’s determination of depreciation reserve to be fair and just, so it took its books and records from the beginning of its operations in 1904, determined the cost of additions and replacements, and extraordinary repairs which could not properly be charged to expense, used the rates adopted by the revenue agent, and computed its depreciation reserve over the period from 1905 to 1918, against which it -charged in each year the cost of additions and replacements amounting to $78,703.40, arriving at a total depreciation reserve at August 31,1918, of $88,528.47. The Commissioner approved the revenue agent’s computation in his determination upon which this proceeding is predicated. The depreciation reserve as computed by the revenue agent and as determined by the petitioner follows:

    By reason of the annual repairs and replacements made by petitioner, the total depreciation sustained by its plant to 1918 was not in excess of 25 per cent.
   OPINION.

Littleton :

We are of the opinion that the position of the petitioner in this proceeding is correct and that it is entitled to have its invested capital for the fiscal years 1919 and 1920 recomputed upon the basis of a depreciation reserve of $88,528.47 at August 31, 1918. The Board’s decisions in the Appeals of Rub-No-More Co., 1 B. T. A. 228; Cleveland Home Brewing Co., 1 B. T. A. 87; Russell Milling Co., 1 B. T. A. 194, and other decisions of the Board holding that, under certain circumstances, the depreciation charged by the petitioner upon its books in prior years should, not be disturbed, have no application to the question here presented, for the reason that the petitioner wrote off no depreciation in the prior years nor did it undertake to set up an accurate depreciation reserve. Unfortunately, it designated its profit and loss, surplus and depreciation account as a Reserve for Depreciation,” and, as the Commissioner in article 844 of his Regulations 45 has said, “ If any reserves for depreciation or for depletion are included in the surplus account it should be analyzed so as to separate such reserves and leave only real surplus.” Petitioner’s books were admittedly inaccurately kept and did not truly reflect surplus or sustained depreciation. The revenue agent and the Commissioner admitted this fact, but they take the position that the petitioner did not convince them that the depreciation reserve of $156,835.61 determined by the revenue agent was not correct. The evidence submitted by petitioner convinces us of this fact. The petitioner has used a fair and reasonable method to determine depreciation reserve. It has used the rates adopted by the Commissioner, and we are convinced from the evidence that petitioner’s determination of the additions and replacements made over the period of years was sufficiently accurate to be entirely fair to itself and to the Government, and we approve it. On the other hand, the determination of the revenue agent, which was approved by the Commissioner, was purely arbitrary throughout and resulted in an erroneous determination of the petitioner’s invested capital for the taxable years. The revenue agent might just as well have started with the “ (Reserve for Depreciation ” shown on the books at the end of the fiscal year 1910, which was zero, instead of the $72,000 shown in that account at the beginning of that year; or he might have taken the balance shown in that account at any other date, which would have produced a different result from that arrived at by him.

Judgment will be entered for the petitioner upon the issues raised on 15 days' notice, under Rule 50.


source: Caselaw Access Project

author: MoRRis:

license: Public Domain

text:
    Popular Dry Goods Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 2141.
    Promulgated February 7, 1927.
    1. Certain expenditures held to be deductible as ordinary and necessary expenses.
    2. Deduction of an alleged bad debt denied.

      E. W. Wotiplca, O. P. A., and Zach Lamar Gobi:, Esq., for the petitioner.

      George E. Adams, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency of $7,039.87, income and profits tax for 1919, 1920, and 1921. The deficiencies result from the disallowance of certain deductions taken in each of the years of amounts spent in giving dances for employees ; from the disallowance of a deduction of $3,498.22 alleged to be a bad debt ascertained to have been worthless and charged off in 1921; and from the determination that certain expenditures in 1921 were not for repairs but were for capital items.
    FINDINGS OP PACT.
    The petitioner is a Texas corporation operating a department store in El Paso.
    It was the practice of the petitioner to hold weekly meetings of the department heads, at -which they were shown a record of their sales for the corresponding week of the preceding year, and prizes were offered to the floors showing the greatest increase in sales. Sometimes payments were made in cash, but, in order that all the employees should benefit, and as an incentive for their services, some few dances or picnics were given throughout the year for the entire force. As a result of this policy the petitioner spent $155.30 in 1919, $171.50 in 1920, and $115 in 1921 for dances for its employees.
    In January of each year the petitioner took an inventory of its merchandise, after which it checked up its accounts. The president went over all the accounts receivable in excess of $50 with the credit man and analyzed them, and the accounts that were past due and unsecured were charged off. The entries were made as of December 31, although the work in connection therewith was not completed until toward the latter part of January. The accounts were then transferred to a loss and gain ledger. Statements on these accounts were sent out every month and other efforts made to collect them. Some of the accounts in this lodger were fifteen years old. The total of such accounts transferred to the loss and gain ledger as of December 81 of each year was deducted from gross income, and subsequent collections thereon were returned as income in the year received. In 1919 the petitioner collected $9,758.78 on these accounts; in 1920, $23,106.47; and in 1921, $12,337.96.
    Included in the accounts charged off as bad debts as of December 31, 1921, was one amounting to $3,498.22, standing in the name of Jose Miledi. Miledi was located in Chihuahua, Mexico, and had maintained an open account with the petitioner for many years. The account was wholesale and was handled personally by Schwartz, president of the petitioner. During the summer months of 1921 Miledi became financially embarrassed. The Mexican attorney of the petitioner advised that to sue would throw Miledi into bankruptcy. Schwartz “ flagged ” the Miledi account with a sticker reading “ Careful — This is K. O., Ask before posting.” The sticker was initialed “ N. M. T. P.” and dated “ 11-24-21.” “ K. O.” meant keep off. Such a sticker was used whenever an account was slow and it indicated not to charge any more until conditions were better.

      Schwartz agreed to sell additional goods to Miledi only for cash, which was to be deposited at the time of purchase, and Miledi was to reduce his old balance by payments from his profits. Between November 2é and December 14, Miledi was allowed to make purchases totaling $1,059.65. During the same period he paid $250 cash and received credit for goods returned of $118.50. On December 14 the balance due was $3,882.22. On that date Miledi gave the petitioner a Mexican acceptance for his indebtedness. The note was endorsed by Schwartz and sent to the petitioner’s agent in Chihuahua for collection on February 27, 1922. On January 6, 1922, Miledi made a cash payment of $384, reducing the balance to $3,498.22. When the books were finally posted in January, 1922, the Miledi account in the amount of $3,498.22, allowance having been made for the payment on January 6, 1922, was transferred to the loss and gain ledger and was deducted from gross income for 1921. Thereafter this account was credited with cash payments in the following amounts on the stated dates:
    January 20, 1922, cash-$96. 00
    February 20, 1922, cash. 289. 20
    April 11, 1922, cash_ 711. 48
    April 14, 1922, cash_ 3S5. 42
    May 4, 1922, cash_ 75. 00
    May 15, 1922, cash_ 200. 00
    June 20, 1922, cash_ 614. 45
    August 7, 1922, cash_ 100. 00
    August 21, 1922, cash — . 91. 90
    The petitioner’s books show that Miledi was allowed to open a new account on April 11, 1922. The cash payments made by Miledi were credited against the old balance, while his new purchases were allowed to accumulate. The new account between April 11 and October 24, 1922, shows but one credit of cash paid amounting to $108.82. On October 24, 1922, the balance shown by the books to be due on the old account was $1,367.58, which included $240 interest on the notes and an additional purchase of goods entered in this account of $192.81. As of that date this balance was transferred to the new account, making a total balance due of $3,188.71. On October 25, Miledi paid cash in the amount of $955.80.
    During 1921 the petitioner expended $19,330.81 for repairs, improvements, betterments and additions. It covered the expenditures made on the four pieces of property owned or under lease by the petitioner during the taxable year 1921. The expenditures were charged to general expense, including the labor and materials. One Glazer, who was in charge of the repairs and alterations, kept memoranda of the expenses and the work done. At the end of the year the expenses were segregated by Glazer and the tax adviser of tlie petitioner. This segregation showed capital items of $4,957.44 and repair items of $14,378.37. The Commissioner allowed $6,185.74 as expenditures for repairs and capitalized $13,145.07, thus disallowing as a deduction $8,187.63, which he distributed as follows:
    Main building_ $787.36
    Hammett Building_:_ 2, 275. 00
    Annex___ 3, 979. 27
    Fixtures- 796. 00
    New carpets- 350.00
    The main building was a six-story brick building with basement, owned by A. Schwartz, president of the petitioner, and leased by it at least since 1914, which lease was renewed July 1, 1921, for fifteen years. The Commissioner segregated the $787.36 disallowed by him for work done in this building, as follows: alterations, $580; pent house, $63.48; radiators, $143.88. The Commissioner allowed as a deduction one-half of the cost of the work on the pent house, which consisted of reinforcing by new beams and posts a beam which had been cracked by the jars of the elevator. Other work done in this building was the repairing of the terra cotta on the fifth floor. In the basement a seepage developed which necessitated reinforcing the walls and floor to keep out the water. Walls and ceilings along the stairways were scratched and defaced by moving fixtures up and down. Some of the plaster fell off the ceiling. In all such cases the plaster had to be replaced and repainted. The floors had to be repaired and also the water pipes and steam pipes.
    On January 1, 1921, the petitioner renewed its lease, for an additional term of fourteen years, on the second floor of the property designated by the Commissioner as the Hammett Building. During 1921 the petitioner expended $3,030 on this property, the total amount of which was deducted as an expense, and $2,275 of which the Commissioner disallowed. The expenditure on this building was for patching the floors and the plaster, painting, fixing a leak in the roof, and repairing the stairway.
    The term “ annex,” as used by the Commissioner, applied to two properties adjoining the main building; one the Bassett property, a three-story brick structure, was purchased on February 16,1920; the other, a two-story brick building purchased from Mrs. Hammett on November 29, 1920. The Bassett and Hammett purchases had to be altered and remodeled in order to facilitate the transaction of petitioner’s business. The window fronts of these two properties were remodeled to correspond with the window fronts of the main building at a cost of $4,957.44, which amount is in addition to the $3,972.27 expended on these properties and disallowed by the Commissioner. These two properties were situated side by side and the interiors of the ground and second floors were thrown together into one large room on each floor by tearing out the partitions and substituting supporting beams and timbers. Plastering, papering, painting and removal of plumbing fixtures and other changes were made to transform the buildings into an operating unit. The Bassett property had a hotel on the second and third floors. The numerous partitions and the plumbing in this building had to be torn out and removed. Connecting doorways were cut through the walls to the main building.
    The Commissioner disallowed the deductions for employees’ dances as well as the deductions for the account of Jose Miledi.
   OPINION.

MoRRis:

The first issue raised is whether the amounts spent by the petitioner in 1919, 1920, and 1921 for dances for employees are ordinary and necessary business expenditures. The petitioner contends that the amounts constituted a bonus to the employees and are therefore deductible. It is unnecessary to determine whether or not these amounts constituted a bonus. It is sufficient that the expenditures were an ordinary and necessary business expense. The evidence convinces us that these amounts were expended because of a direct business benefit to the petitioner. The offer was made by the corporation to the employees that in consideration of an increase in sales volume the petitioner would do certain things. Employees’ dances were one of the inducements held out to the employees to increase the sales total. Under the circumstances, we are of the opinion that the amounts expended for these dances during the taxable year in question are deductible.

The second issue relates to the Miledi account. The account was charged off as a bad debt by the petitioner in line with a consistent business practice for years of not carrying doubtful accounts as assets. The Commissioner disallowed its deduction for the reason that there was no ascertainment of worthlessness. The findings of fact amply set forth the situation with regard to this account. The president of the petitioner testified that he determined the account to be worthless when he “ flagged ” it with a sticker, but he further testified that these stickers were used whenever an account was slow and they indicated not to charge any more until conditions were better. There is considerable difference between a slow account and one that is ascertained to be worthless. We do not doubt that the Miledi account was thought to be doubtful, but the facts in connection therewith indicate to our minds that there was not an ascertainment of worthlessness. The petitioner held Mexican acceptances for the amount of the debt which were given shortly before the close of the year 1921. A collection was made within six days after the close of that year, a fact which the petitioner recognized by deducting as of December 31, 1921, the balance of the account after the payment on January 6, 1922. Between January 20, 1922, and August 21, 1922, inclusive, Miledi paid $2,563.45, which was applied to the account. He was allowed to open a new account in April, to which, on October 24, 1922, the balance of the old account was added, thus restoring it to an active status. In view of these facts, the deduction of $3,498.22 claimed by the petitioner for 1921 is disallowed.

In regard to the expenditures made by the petitioner on the properties owned and leased by it, we have previously distinguished between expenditures which are deductible as ordinary and necessary expenses and those which should be capitalized, in the Appeal of Illinois Merchants Trust Co., 4 B. T. A. 103, 106, in which we said:

In determining whether an expenditure is a capital one or is chargeable against operating income, it is necessary to bear in mind the purpose for which the expenditure was made. To repair is to restore to a sound state or to mend, while a replacement connotes a substitution. A repair is an expenditure for the purpose of keeping the property in an ordinarily efficient operating condition. It does not add to the value of the property, nor does it appreciably prolong its life. It merely keeps the property in an operating condition over its probable useful life for the uses for which it was acquired. Expenditures for that purpose are distinguishable from those for replacements, alterations, improvements or additions which prolong the life of the property, increase its value or make it adaptable to a different use. The one is a maintenance charge, while the others are additions to capital investment, which should not be applied against current earnings. * * * Appeal of Simmons & Hammond Manufacturing Co., 1 B. T. A. 803.

Applying this reasoning to the instant facts, we are satisfied that the $787.36 which was spent in the main building and disallowed by the Commissioner is properly deductible, and that $2,275 of the $3,030 expended on the Hammett property and disallowed by the Commissioner was an ordinary and necessary expense and deductible as such.

The expenditures on the annex, or Hammett and Bassett properties, were principally for the conversion of those properties into an operating unit. They were not for repairs but for alterations which made the properties adaptable to a different use. Expenditures for such alterations, although they do not increase the value of the property, are not deductible from gross income. We have no evidence on the items disallowed by the Commissioner under fixtures and new carpets, and therefore approve his determination in that respect.

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


author: Morris :

text:
    Virginia Carolina Securities Corporation and Subsidiary Companies, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7484.
    Promulgated February 7, 1927.

      Frederick L. Pearce, O. P. A., for the petitioner.

      Harold, Allen, Esq., for the respondent.
   Morris :

This is a proceeding for the redetermination of deficiency in income tax for the calendar year 1921 of $972.76.

findings of fact.

The petitoner is a Virginia corporation, a holding company with two affiliated subsidiary companies, namely, the Carolina & Worth-eastern Railroad Co. and the Albemarle Steam Navigation Co., with principal office at Suffolk. The Carolina & Northeastern Railroad Co. was operated under Federal control during the period from January 1, 1918, to March 1, 1920. It had no contract with the Director General of Railroads. During the year 1921 the Carolina & Northeastern Railroad Co. received $15,000 from the United States Railroad Administration as compensation for the period of Federal control. The company allocated the amount received as income accrued during the period from January 1, 1918, to March 1, 1920, and reported none of the amount as income for the year 1921 upon the amended consolidated return which was filed for that year, and showed a net loss of $3,272.41. The books of the petitioner and its subsidiary companies during the years 1918 to 1921, inclusive, were kept on the accrual basis and the income-tax returns were filed on that basis.

The Commissioner added to the consolidated income for the year 1921 the amount of $15,000 received from the Railroad Administration and determined the consolidated net income to be $11,727.59.

Judgment will be entered for the petitioner on 10 days notice, under Rule 50. Appeal of Illinois Terminal, Co., 5 B. T. A. 15, and Appeal of Cincinnati, Findlay & Ft. Wayne Ry. Co., 5 B. T. A. 108.


author: Milliken:

text:
    Belvidere Lumber Co., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 12045.
    Promulgated February 7, 1927.
    A corporation filing a separate return for 1922 may not subsequently file a consolidated return for that year.

      B. N. Page for the petitioner.

      A. George Bouchard, Esq., for the respondent.

      This is a proceeding for the redetermination by the respondent of a deficiency in income tax for the calendar year 1922 in the amount of $954.69. The sole issue presented is whether the petitioner, having filed a separate return for the year 1922, may subsequently file a consolidated return pursuant to the provisions of section 240 of the Revenue Act of 1921.
    BINDINGS OP PACT.
    Petitioner, a Vermont corporation, with its principal office at Hyde Park, was organized in 1919 for the purpose of taking over from the Lamoille County Savings Bank & Trust Co. certain real property previously acquired by the latter through foreclosure proceedings.
    In 1922 the petitioner was in need of additional funds to carry on its business, which could not be furnished under the laws of Vermont by the Lamoille County Savings Bank & Trust Co. To meet this situation, the Lamoille Realty Co. was organized in October, 1922, to which company petitioner’s real property and plant were transferred.
    After the organization of the Lamoille Realty Co. and during the remainder of the year 1922, its capital stock and that of the petitioner was held as follows:

    For the taxable year 1922, petitioner filed a return for Federal income-tax purposes, as a separate company, in which it reported a profit of $14,430.30 from the sale of its properties to the Lamoille Realty Co. The respondent has held that the gain derived from the sale was $37,563.11.
   OPINION.

Milliken:

Section 240(a) of the Revenue Act'of 1921, provides that corporations which are affiliated within the meaning of that section may, for any taxable year beginning on or after January 1, 1922, make a separate return, or, under regulations prescribed by the Commissioner, make a consolidated return. The statute, thus, in the case of affiliated corporations, provides two ways in which returns may be filed. Either return is a correct and proper return, but the .return that is filed is the only return recognized by the law and upon which’ the taxes due thereunder shall be computed and determined.

We decided, in R. Downes, Jr. v. Commissioner, 5 B. T. A. 1029, that a separate return could not be subsequently filed, where a joint return had been filed pursuant to the provisions of section 223 of the Revenue Act of 1921. The decision in R. Downes, Jr. v. Commissioner, supra, is decisive and controlling in the instant proceeding.

Decision redetermining the deficiency for 19%% to be $954-69 will be entered.


author: Milliken :

text:
    Greenabaum Brothers, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7757.
    Promulgated February 7, 1927.
    An appraisal based on cost of reproduction as of March 1, 1913, does not establish actual value as of that date.

      Andrew S. Wilson, C. P. A., for the petitioner.

      D. D. Shepard, Esq., for the respondent.
    This proceeding results from the determination by respondent of a deficiency in income and profits taxes for the year 1917, in an amount less than $10,000. Petitioner alleges error in that the respondent, in the determination of net income for 1917, failed to allow the March -1, 1913, value of buildings for depreciation purposes; failed to restore and allow depreciation on items charged to expense from 1910 to 1910, and failed to make an adjustment of the reduction of the machinery account reduced in 1910 on the books of a predecessor partnership. At the hearing, petitioner waived the issue relating to the restoration of items charged to expense during the years 1910 to 1916.
    FINDINGS OF FACT.
    The petitioner is a Delaware corporation, organized in 1912, and has its principal place of business at Seaford. The business of the corporation was originally conducted by one Greenabaum and one Van Lear, as a partnership. That partnership was dissolved in 1909 and the business was taken over by another partnership composed of Greenabaum and one Stephany, which continued until the petitioner corporation was organized in 1912.
    The buildings owned by petitioner consisted of a group of warehouse and factory buildings. One of the buildings had been erected in 1907 by the predecessor partnership. The partnership purchased the materials and the actual building was done by their regular employees. The fixed assets of the earlier partnership, as shown by the books, on May 1, 1909, were: Machinery, $29,385.44; buildings, $12,600; land $8,000; office furniture, $300. The total book value was $50,285.44. These assets were set up on the books of the subsequent partnership at its formation in January of 1910, under one item of $40,000. The buildings and machinery items were set up on the petitioner’s books in 1912, the year of incorporation, as costing it $12,700 and $21,951.50, respectively.
    During 1914 the petitioner had an appraisal of its buildings made for insurance purposes. The appraiser had long been in the business of a building contractor and was experienced in making appraisals for insurance purposes. The value of the buildings, based upon the cost of reproduction, was determined by the appraisal to be $44,109 at that time, and the replacement cost as of March 1, 1913, was approximately the same.
   OPINION.

Milliken :

No evidence, other than the mere showing of entries of the predecessor partnership and of the petitioner, was offered at the hearing concerning the alleged error in respondent’s failure to restore to capital account and allow depreciation on the amount by which the machinery account was reduced on the books of the predecessor partnership. Obviously, such evidence is insufficient to warrant us in disturbing the respondent’s determination upon this point.

With respect to the March 1, 1913, value of the buildings, the only evidence adduced was the testimony of a person who made an appraisal in 1914 upon the basis of the replacement cost. Even though we accept the appraisal made in 1914 as establishing the reproduction cost as of March 1, 1913, we are unable to determine the actual value of the buildings on March 1, 1913, as replacement cost gives no dependable index to actual value. Appeal of Kinsman Transit Co., 1 B. T. A. 552; Appeal of Valley Steamship Co., 1 B. T. A. 1107; Appeal of Rockford Malleable Iron Works, 2 B. T. A. 817. Being unable to determine the March 1, 1913, value, we must sustain the action taken by the respondent.

Judgment will be entered for the respondent.


text:
    C. B. Haynes Co., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 7192, 15121.
    Promulgated February 7, 1927.
    The evidence being inconclusive as to losses actually sustained within the taxable years on account of unsalable merchandise, the respondent’s refusal to accept a recomputation of inventories for those years approved.

      DeWitt T. Ware, G. P. A., for the petitioner.

      F. O. Graves, Esq., for the respondent.
    These proceedings result from the determination by respondent of deficiencies in income and profits taxes for the calendar years 1919, 1920, and 1921, in the respective amounts of $6,244.86, $3,213.97 and $1,689.91. The appeals for all years have been consolidated for hearing and decision. Error is alleged concerning the year 1919, in that respondent denied petitioner’s application for assessment of profits tax, under the provisions of section 328 of the Revenue Act of 1918. Error is alleged concerning the years 1920 and 1921, in that respondent refused to accept a recomputation of inventories for those years, wherein there were excluded by petitioner unsalable phonograph records.
    FINDINGS OF FACT.
    Petitioner is a Virginia corporation with principal office located at 19 West Broad Street, Richmond, and was, during the years in question, a wholesale and retail dealer in Edison phonographs, phonograph records and accessories. Inventories for 1920 and 1921 were taken on the basis of cost and were so reported in returns filed for the years in question. Phonograph records were recorded in the inventory at cost, with adjustments each year reflecting the then cost or replacement value. During 1920 the stock holdings in the corporation changed, and the new officials became aware of the fact that the corporation had on hand many phonograph records that were unsalable and that there was no demand by the public for certain records. In March or April, 1921, a card system reflecting the value of each phonograph record was made and the cards segregated according to the current marketability of the various records. As a result of such segregation, it was concluded that on December 31, 1920, the corporation had on hand 55,281 phonograph records of the then cost value of $42,360.05, which represented unsalable merchandise. For the year ended December 31, 1921, the corporation carried forward at cost, in its inventory, the 55,281 phonograph records it had concluded were unsalable at December 31, 1920, at the then replacement cost of $46,364.77. Represented in the records determined by the corporation to be unsalable were phonograph records purchased during the year 1916 and succeeding years, with a large percentage of the records having been purchased in the year 1919. Many of the records purchased in 1916 had become worthless in 1916, and this situation obtains concerning records purchased in the years 1917, 1918, and 1919, which were included in the unsalable records determined as of December 31, 1920.
   OPINION.

Milliken:

No evidence whatsoever was introduced by petitioner respecting its claim to have its profits taxes computed pursuant to the prolusions of section 328 of the Revenue Act of 1918, and, accordingly, the refusal of the respondent to so compute its taxes is approved.

We entertain no doubt that, included in petitioner’s inventory at the close of the years 1920 and 1921, there were represented phonograph records which had become worthless. We have no evidence upon which to base an opinion as to the number, date of purchase, or cost of the records that became worthless during the years in question. The president of the petitioner testified that many of the phonograph records, which he determined to be worthless in 1921, had been purchased as far back as the year 1916 and that the records became worthless in the year purchased, and also that the bulk of the records determined to be worthless as of December 31, 1920, had been purchased in the year 1919 and became worthless during the year of purchase. He was also unable to state the number of records purchased during the years 1920 and 1921, or the number of records purchased during those years that became worthless. In the circumstances, we are of the opinion that the proof of loss in the years 1920 or 1921 is inconclusive, and for this reason the respondent, in disallowing the reduction of inventory with respect to phonograph records, is sustained. Appeal of R. A. Bartley, 4 B. T. A. 874.

Judgment will he entered for the respondent.


text:
    Elm City Nursery Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6503.
    Promulgated February 7, 1927.
    Cost of goods sold within the j'ears in question, together with other amounts which were added to inflate financial statements, found to have been added to inventories and eliminated therefrom.

      Charles F. Mitchell, Esq., for the petitioner.

      Henry Bavenel, Esq., for the respondent.

      This proceeding results from the determination by respondent of deficiencies in income and excess-profits taxes for the calendar years 1919 and 1920, in the respective amounts of $2,390.68 and $1,474.42. Petitioner alleges error in two respects; first, failure of respondent to allow for the cost of goods purchased and sold during both years, in the total amount of $14,720.95; second, failure of respondent to eliminate for both years appreciation of inventory in the total amount of $18,424.46.
    FINDINGS OP PACT.
    Petitioner is a Connecticut corporation with its principal offices at Woodmont. From 1906 to 1922, the corporation was controlled and operated by Ernest F. Coe, the operations being carried on principally with borrowed capital. During the years 1919 and 1920, the financial condition of the corporation became precarious, which necessitated the borrowing of substantial sums, if the corporation was to continue in business. Banks to whom Coe applied for loans required a balance sheet showing its assets and liabilities. In order to make as favorable a statement as possible, Coe caused the inventory of nursery stock to be overstated at inflated values, for credit purposes. The inventory was used as a balancing figure for the purpose of showing an inflated financial condition. No physical inventory was made of the stock on hand, and stock purchased, and sold during the year was not taken into account. If an additional sum was needed to be shown on the financial statement, an arbitrary sum was added to the closing inventory to effect such result. The value of inventory at January 1,1919, is stated on the books of account to be $164,523.07, and the additions thereto during the year 1919 amounted to $21,206.77, of which $7,495.34 is shown as cost of purchases and $13,711.43 represents a balancing figure added to the value of the inventory at the close of the year. The inventory, as set up on the books at January 1, 1919, with charges to the account during the year, amounted to $185,729.84, and this amount appears upon the books of account as the value of the inventory at December 31, 1919. The total charges to the account for the year 1920 amounted to $11,938.64, of which $7,225.61 is shown as cost of purchases, and $4,713.03 represents a balancing figure added to inventory at close of year. The inventory at January 1, 1920, amounted to $197,668.48, and this figure appears upon the books of account as the value of the inventory at the close of the year. Purchases made during the years 1919 and 1920 represent stock purchased and used to fill orders during each of the years and the purchases of stock made during the years were not on hand at the close of the years.
   OPINION.

Milliken :

The respondent, in computing net income for the years in question, has not allowed deductions, as part of cost of goods sold, of the cost of purchases of stock in the amounts of $7,495.34 and $7,225.61, respectively. The inventory of stock for each of the years and the cost of purchases of additional stock were carried on the books of account in a so-called “ nursery stock ” account. The inventory at January 1, 1919, is stated therein at a value of $164,-523.07,' and the additions thereto during the year amounted to $21,206.77, of which $7,495.34 is shown as cost of purchases, and $13,711.43 as a balancing figure added to the inventory at the close of the year, or an appreciation of the inventory. The same situation is reflected as concerns the year 1920, as set forth in the findings of fact.

The respondent’s computation of net income, for each of the years in question, was based upon the debits and credits to the profit and loss account as it appeared upon the books. Though he made some adjustments in respect of other items, ho accepted the book value of the inventories as correct and the credits to profit and loss of the two items of appreciation of inventories as proper. We are convinced that the books of account did not correctly reflect the actual and true situation. The petitioner has proven that such is the fact.

The evidence also convinces us that all of the nursery stock purchased during the year was acquired for the purpose of filling orders for stock; that it was actually used for this purpose, and was not on hand at the close of the respective years. Hence, petitioner’s books are in error in carrying the cost of these purchases in the inventory at the close of the year.

Deducting from the value of the inventory as set up on the books at December 31, 1919, to wit, $185,729.84 — an appreciation of $13,-711.43, and cost of purchases in the sum of $7,495.34, and from the book value of inventory at December 31, 1920, to wit, $197,668.48, the total appreciation of $18,424.46 and the total purchases of $14,-720.95, the corrected inventories at both dates are found to be in the same amount of $164,523.07. Since the inventories at the opening and close of both years are the same, the cost of goods sold for each year is represented by the cost of the purchases made during the year.

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


author: Milltken:

text:
    The W. K. Henderson Iron Works & Supply Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 518, 3555, 10501.
    Promulgated February 9, 1927.
    In tbe absence of evidence showing that additional compensation was paid or accrued during 1918, tbe respondent’s disallowance of tbe deduction on account thereof is sustained. There being no evidence as to the reasonableness of such additional amounts as compensation for 1919, no deduction is allowable in the latter year.

      Yandell Boatner, Esq., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the respondent.
    These proceedings result from the determination by respondent of deficiencies in income and excess-profits taxes for the years 1918 to 1921, inclusive. The deficiency in tax for the year 1918 is less than $10,000. For the year 1919, the deficiency is $2,954.63, and for the two years 1920 and 1921, there is a deficiency of $10,810.02. The three appeals, filed for the four years in question, were consolidated at date of hearing. Petitioner alleged errors in the computation of the deficiencies in question, raising the issues that a reasonable rate of depreciation had not been allowed; that certain expense items had been disallowed, and that invested capital had been improperly decreased for certain of the years in question. These three assignments of error were specifically waived and withdrawn by petitioner at the hearing, leaving only one issue involved in these proceedings, and that relates to the disallowance by the respondent of deductions for additional salaries for the years 1918 and 1919.
    FINDINGS OP PACT.
    Petitioner is a Louisiana corporation with its principal office in Shreveport. Its business is the manufacture and sale of machinery and supplies; its books of account were maintained and its income and profits-tax return was filed on the calendar year basis. During the year 1918 the total sales of the petitioner approximated $750,000, its physical properties were assessed at over $1,000,000 for city, county and State tax purposes, and the weekly pay roll during the year was approximately $7,500.
    During 1918 the principal officers of the petitioner were a president, vice president and general manager. The president, W. K. Henderson, died in September, 1918, and upon the death of the father, his son ~W. K. Henderson, Jr., became president of the petitioner for the period September, 1918, to December-31, 1918. His services to the petitioner consisted largely in arranging for necessary finances to secure the efficient operation of the business. W. S. Duncan, the vice president and general manager, was in charge of production during the year 1918.
    A salary of $6,666.68 was paid W. K. Henderson, Sr., during the year 1918, as president of petitioner for the period January 1, 1918, to the date of his death. W. K. Henderson, Jr., was paid a salary of $3,333.33 during the year 1918 for services performed during the period September to December 31, 1918. W. S. Duncan was paid during the year 1918 a salary of $7,149.96 for services rendered during the year 1918. Some time during the latter part of 1918 or the first part of 1919, W. K. Henderson, Jr., and W. S. Duncan discussed the matter of the adequacy of the salaries they were receiving from the petitioner for the services they had performed and were performing. During the course of their conversation Henderson agreed with Duncan that their salaries were inadequate and they both decided that they should each receive an additional salary of $10,000 for the year 1918 for services rendered during the year 1918. During 1919, $20,000 was credited as additional compensation to W. K. Henderson, Jr., and W. S. Duncan.- In his individual income-tax return for 1918, W. K. Henderson, Jr., included the additional $10,000 thus credited to him and paid the tax due thereon.
    No directors’ meetings were held nor were minutes recorded, with respect to the additional compensation which W. K. Henderson, Jr., and W. S. Duncan agreed upon for services rendered during the year 1918.
   OPINION.

Milltken:

Section 234(a)(1) of the Revenue Act of 1918 provides that, in computing the net income of the corporation, there shall be allowed as deductions all of the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for services actually rendered. We were not informed whether the petitioner maintained its books of account upon the cash receipts and disbursements basis or upon the accrual basis. If upon the former, the additional salaries sought to be deducted from income, for the year 1918, must have been actually paid. The additional salaries were not paid during the year 1918. If the books of account were maintained upon the accrual basis for the year 1918, a liability must have been incurred in that year to pay the additional salaries in question, in order that the salaries could be claimed and allowed as a deduction in computing net income. The president of the petitioner testified that he was unable to state whether the agreement concerning the additional salaries for the year 1918 was entered into in the year 1918 or the year 1919, and consequently no liability to pay additional salaries having been proven for the year 1918, no deduction from income can be allowed therefor.

Petitioner avers that if the additional salary deductions are not allowed for the year 1918, the same certainly consitutes a deductible item from income for the year 1919 when the salaries were actually paid. It may be that such additional salaries paid in 1919, when added to the regular salaries paid in 1919, constitute a reasonable compensation for personal services actually rendered in that year, but we have no evidence before us concerning the salaries paid, services performed, or the volume or character of business done during the year 1919, and we are, accordingly, without the necessary facts to determine the issue for that year.

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

Antradeul and Phillips dissent.


author: Miijjken:

text:
    Joe R. Miller, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3013.
    Promulgated February 9, 1927.
    A joint return of busband and wife having been filed for 1922, community property returns may not be subsequently filed for that year.

      C. M. Pasquier, G. P. A., for the petitioner.

      J. Arthur Adams, Esq., for the respondent.
    Petitioner appeals from the determination by respondent of a deficiency of $51.87 in income tax, for the calendar year 1922, and alleges as error the refusal by respondent to compute the tax upon the basis of a separate return of income to the petitioner, he having filed a joint return for himself and wife.
    FINDINGS OF FACT.
    Petitioner is an individual residing at Minden, La. He filed, within the time allowed by law, a Federal income-tax return for the calendar year 1922. Such return stated he was a citizen of the United States, that it was a joint return of husband and wife, that he was married and living with his wife, and that he claimed one dependent under 18 years of age and a personal exemption of $2,400. The return disclosed a tax due of $84.15, and the respondent determined the deficiency here in question of $51.87, upon the basis of a single, joint return, rejecting petitioner’s contention that he should be allowed to file community property returns, reporting one-half of the total income as his and one-half as income of his wife.
   OPINION.

Miijjken:

We have decided, in R. Downes, Jr. v. Commissioner, 5 B. T. A. 1029, that the contention made by petitioner is contrary to the express provisions of the law, and this proceeding falls squarely within that decision.

Decision redetermining the deficiency for 19%% to be $51.87 will be entered.


author: Tetjssell :

text:
    Appeal of Tschudy Lumber Co.
    Docket No. 3293.
    Promulgated February 9, 1927.
    Invested capital. — Evidence produced in support of a claimed capital value of a logging contract held to be insufficient to support the values claimed and insufficient to warrant the Board in finding any definite capital value for such contract.

      Franklin G. Parks, Esq., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the Commissioner.
    The petitioner complains of a deficiency letter dated February 11, 1926, asserting a deficiency in income and profits taxes for the calendar year 1918 in the amount of $23,146.98, and prays for a rede-termination of such deficiency.
    The petitioner alleges that the Commissioner erred in excluding from invested capital for the year 1918 the amount of $220,282.09 as paid-in surplus, representing the value of a contract for the purchase of logs, and that he further erred in disallowing a deduction for the year 1918 in the amount of $10,446.52, representing exhaustion of the value of the said contract.
    FINDINGS OF FACT.
    The petitioner is a Tennessee corporation with its principal office at Kansas City, Mo.
    The corporation was organized in 1910 with an authorized capital stock of $25,000, all of which was owned by E. W. Tschudy, except for a few qualifying shares. Until 1916 the taxpayer was engaged in the business of the manufacture of hardwood logs into lumber at its mill at Memphis. Its supply of logs was bought on the open market. The petitioner built a saw mill at Weona, Ark., and started operations there in 1916. The petitioner also did a great deal of mill work for the J. II. Tschudy Hardwood Lumber Co., a corporation with its principal office at Kansas City, which was engaged in the business of the sale of the lumber but did no manufacturing. The stock of the latter corporation was owned by J. H. Tschudy and his three sons, Jay, Robert, and Frederick Tschudy. J. H. Tschudy is a brother of E. W. Tschudy, but prior to 1913 neither J. H. Tschudy nor his three sons held any stock in the Tschudy Lumber Co.
    All the Tschudys purchased logs from the St. Francis Valley, Ark., timber district and were acquainted with the value of logs from that district. They also knew of a large tract of timberland in the St. Francis Valley, known as the Collins Tract, containing approximately 27,000 acres.
    In 1912 the Tschudy group learned that this land could be purchased for $20 per acre. Other similar timber land in the immediate vicinity had been sold in 1910 for $25 per acre, and in 1912 for $30 per acre.
    Jay Tschudy, representing the Tschudy group, and F. S. Chariot agreed orally in 1912, or early in 1913, to purchase jointly the Collins Tract. F. S. Chariot was a large stockholder in the Truman Cooperage Co., which owned an adjoining tract of timberland. Chariot was also interested in the Ozark Lumber & Cooperage Co. and the Cairo, Truman & Southern Railway Co., the tracts of which extended in 1912 to the Truman Cooperage Co.’s holdings. After a cruise the Collins Tract was found to contain 130,000,000 feet log scale of timber suitable for the Tschudy purposes and 70,000,000 feet suitable for the Chariot purposes.
    On February 14, 1913, a final agreement was reached by Jay Tschudy and Chariot to the effect that a corporation should be organized to take title to the Collins Tract; that the Chariot parties should take half of the stock of that corporation and the Tschudy parties the other half; that the purchase should be jointly and equally financed; that the Tschudys should be permitted to acquire at once one-half of the stock of the Cairo, Truman & Southern Railway Co., by means of which the logs were to be made available; that the corporation to be formed (i. e., the Weona Land Co.) should enter into a contract with a corporation to be designated by the Tschudys for certain species and sizes of logs at specified prices, as agreed between Chariot and Jay Tschudy, and also to enter into a similar contract with a corporation to be designated by Chariot. This agreement was oral, except for memoranda made by the parties and their attorney. On the same day Chariot and Jay Tschudy met Collins, representing E. A. Nixon, owner of record of the Collins Tract, and orally agreed to purchase the said timberland.
    At the time these negotiations were in progress it was understood and agreed among the five Tschudys that the capital of the Tschudy Lumber Co. should be increased, and that the five Tschudys should become the stockholders and the officers and directors of that corporation. It was also agreed that the Tschudy Lumber Co. should receive the logs from the Collins Tract.
    The written contract for the purchase of the Collins Tract was executed on March 18, 1913, between E. A. Nixon, as the seller, and four corporations, including the petitioner, the J. H. Tschudy Hardwood Lumber Co., the Ozark Cooperage & Lumber Co., and the Truman Cooperage Co., as the purchasers. The contract provided for the sale of the tract at a price of $20 per acre, the total amount being $535,288.80. Under the contract an initial cash payment of $10,000 was to be made on the date of the contract, a second payment of $15,000 within 90 days, and a further payment of $25,000 six months after the date of the contract. The contract further provided that a new corporation with a full paid-in capital stock of $100,000 was to be organized to take title to the land, and that, after the above-mentioned payments on the purchase price and the organization of the new corporation, the obligation of the Ozark Cooperage & Lumber Co. and the J. H. Tschudy Hardwood Lumber Co. should cease and terminate, except for the further provisions that the purchasers furnish the seller with copies of the minutes of the various boards of directors or other corporate authority sufficient to show binding corporate action authorizing the execution of the contract, and the further provisions that the purchasers guarantee to the seller or holder of the notes secured by deed of trust to keep and perform the covenants contained in the deed of trust. The contract provided further that, upon the payment of the $25,000 above mentioned, the seller should deed the property to the new corporation to be organized, and the balance of the purchase price should be represented by notes executed by the said new corporation, the Truman Cooperage Co. and the Tschudy Lumber Co. jointly, such notes to be secured by a deed of trust. The initial payment of $10,000 and the second payment of $15,000 were made by the purchasers as required under the contract on behalf of the Weona Land Co., which repaid these advances.
    In or about April, 1913, the new corporation contemplated in the contract of March 18,1913, was formed under the name of the Weona Land Co. One-half of the.stock of this corporation was taken by the Tschudy parties and the other half by the Chariot parties.
    On June 5,1913, a certificate authorizing the increase of the capital stock of the petitioner from $25,000 to $100,000 was issued by the Secretary of State of Tennessee. All of the old stock was turned in to the petitioner and canceled, and on November 15, 1913, the new capital stock was issued, at par, to E. W. Tschudy, 250 shares, and to J. H., Jay, Eobert, and Frederick Tschudy, 18U/2 shares each. In payment for the new stock E. W. Tschudy left in the corporation all of its assets, including the saw mill at Memphis, with the equipment, logs, lumber, and cash on hand to a total value of about $32,898.70. The other recipients of the capital stock each paid in, in lumber and cash, $18,750. The $100,000 of authorized capital stock was thus fully-paid in.
    On September 18, 1913, the third payment required under the contract of March 18, 1913, was made by the Weona Land Co., and on the same date a deed to the Collins Tract was given by E. A. Nixon and his wife running to the Weona Land Co., the Truman Cooperage Co., and the petitioner, as grantees. On November 1, 1913, the Truman Cooperage Co. and the petitioner gave a quitclaim deed of the land running to the Weona Land Co.
    On September 18, 1913, the Weona Land Co. entered into a contract with the petitioner giving it the right to purchase all logs of certain sizes and species cut from the entire Collins Tract, delivery to be made on board the cars at the spur track of the Cairo, Truman & Southern Railway Co. The contract fixed the prices of $6.50 per thousand feet, log scale, for certain sizes and species, and $2.50 per thousand feet for logs of certain other sizes and species. To these prices there was to be added for the first year in which the contract should be in force a sum of $4.25 per thousand feet to represent the cost of logging from the stump to delivery on board the cars. This logging charge was subject to revision at the expiration of one year, if required by circumstances. On the same date a similar contract was entered into by the Weona Land Co. with the Truman Cooperage Co.
    The Weona Land Co. was organized for the purpose of holding title to the timberland and cutting the timber. It was not intended to make any profits and the charges made against the Truman Cooperage Co. and the petitioner were to cover the purchase price of the timberland and the cost of logging. The profits were to be made by the Truman Cooperage Co. and the petitioner. The petitioner, prior to entering into this contract, bought on the market for $15 per thousand feet, log scale, and $11 per thousand feet the same species and sizes of logs it was to get from the Weona Land Co. for $6.50 and $2.50 per thousand feet, respectively, plus logging costs.
   OPINION.

Tetjssell :

This proceeding presents for determination (1) whether a certain logging contract had a capital value, and the amount of such value, if any; (2) whether such contract came into the possession of the petitioner as a contribution of capital in the nature of paid-in surplus; and (3) the allowance of an annual deduction from gross income based upon the gradual exhaustion of such capital value.

We have no doubt that business contracts, under which operations are to continue over a period of years, can properly be said to be valuable to both or all parties to such contracts. The contract here in question no doubt might have been the subject of sale or exchange, and if such sale or exchange had occurred, it might have established a capital value in such contracts, but no such exchange has taken place. It appears probable that the petitioner, either late in 1918 or early in 1914, began operations under this contract. Later, in the early part of 1918, it seems to have posted this contract on its books of account at a capital value of $260,000. Its valuation witness produced at the trial computed a value of $318,839.75, using an apparent difference between the cost of logs under this contract and the price at which the petitioner had purchased logs during the years 1911 and 1912, and applying a mathematical formula to such difference in cost over an estimated period of operations of twenty years. The computation of this valuation expert is not persuasive. An apparent differential in the cost of logs plus a mathematical formula, while perhaps sometimes useful, is not, standing alone, proof of capital values.

The evidence does not satisfactorily show whether the logs which were to be furnished under this contract would be of the same or similar nature to the logs purchased by the petitioner in the Memphis market. While the record of this case does not show the basis upon which logs are purchased in the Memphis market, it is taken for granted that the cash price of logs in that market is fixed after inspection of the particular logs to be purchased and is not based upon standard grades. The record is wholly lacking in proof that the logs to be acquired by the petitioner under the contract could or might have had a selling price equal to the figures at which the petitioner had purchased logs in the Memphis market.

In one of its earliest decisions (Dwight & Lloyd Sintering Co., 1 B. T. A. 179) the Board took the position that in ascertaining the capital value of an operating contract it would consider the results of operations under that contract in years subsequent to the basic date. At the time of the trial of this case the petitioner presumably had been operating under this contract for upwards of twelve years, and yet the record is silent as to what such operations produced in the matter of gains or losses, as well as the kind and quantity of logs procured under the contract. We are thus constrained to hold that the record of this case, so far as evidence of value of this logging-contract is involved, is insufficient to support either the estimated value placed on it by the petitioner in 1918, or the computed value offered in evidence at the trial, and that the Board would not be warranted, upon the evidence, in undertaking to establish any figure of capital value.

Having arrived at this conclusion, the petitioner’s .claim for exhaustion necessarily fails, and there is no occasion for making any findings as to whether the contract came into the hands of the petitioner as a contribution of capital.

The deficiency may be recomputed in aceord-_ance with the foregoing opinion, pursuant to Rule f>0, and judgment will be entered in due course.


author: Murdock :

text:
    S. George Ullman, Executor, Estate of Rudolph Valentino, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4477.
    Promulgated February 9, 1927.
    Where a husband had a contract of employment for throe years, beginning in 1922, and in that year an interlocutory decree of divorce was entered in California, relating to his marriage, and thereafter he paid his wife $32,000 in consideration of which she relinquished all right and claims which she might have under the community property laws of California to the income which he would receive under his contract of employment, any expense incurred by him as a result of this transaction is not deductible under section 214(a) (5) of the Revenue Act of 1921.

      Rolland L. Nutt, Esq., and Lawrence P. Mattingly, Esq., for the petitioner.

      Brice Toole, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income taxes for the year 1922, amounting to $1,591.59, resulting from the Commissioner’s disallowance as a deduction of the amount of $12,000 paid by Rudolph Valentino to his wife in 1922, and claimed as a loss in that year. The iietition was filed by Rudolph Valentino prior to his death. He died August 28, 1926, and at the hearing on appeal a suggestion of death was filed by counsel and motion made and granted that “ Estate of Rudolph Valentino, S. George Ullman, Executor,” be substituted as party petitioner.
    The facts were stipulated.
    FINDINGS OF FACT.
    Rudolph Valentino Guglielmi was ,a motion picture actor, professionally known as Rudolph Valentino, who, during the year 1922, and for several years prior thereto, was domiciled m the County of Los Angeles, State of California.
    At the beginning of 1922, Rudolph Valentino Guglielmi was the husband of Harriet H. Guglielmi, a motion picture actress, professionally known as Jean Acker, the marriage having taken place in Los Angeles on November 5, 1919. He was employed by the Famous Players-Lasky Corporation under a three-year contract beginning in 1922, which contract was entered into subsequent to November 5, 1919. On March 9, 1922, he was awarded an interlocutory decree of divorce from his wife by the Superior Court of the State of California, County of Los Angeles. Shortly thereafter he entered into a written agreement with Harriet H. Guglielmi whereby he paid to her $12,000 in the year 1922, in consideration of which she agreed to relinquish all right or claims which she might have under the community property laws of California to the income which her husband would receive under his contract of employment above mentioned. All of the income which he received under the aforesaid contract was earned and paid to him in 1922, he having abandoned said contract during the latter part of that year. A final decree of divorce was entered on March 12, 1923.
    In his income-tax return for 1922 he reported all said income received from the Famous Players-Lasky Corporation, less the $12,-000 which he paid during that year to his wife as aforesaid.
    The respondent increased the taxable income by $12,000, disallowing said reduction.
   OPINION.

Murdock :

The petitioner contends that there should be deducted from income for 1922 the amount of $12,000, under the provisions of section 214(a) (5) of the Revenue Act of 1921, which reads as follows:

Sec. 214. (a) Tliat in computing net income there shall be allowed as deductions:
(5) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business * * *.

The contract and any income which might be received from it up to the date of the final decree of divorce would, no doubt, be community property under the Civil Code of California, section 164 of which reads as follows:

§ 164. Community property. All other property acquired after marriage by either husband or wife, or both, including real property situated in this state, and personal property wherever situated, heretofore or hereafter acquired while domiciled elsewhere, which would not have been the separate property of either if acquired while domiciled in this state, is community property * * *.

The ground for divorce was neither adultery nor extreme cruelty, and the following portion of section 146 of the same code applies:

* * * In case of the dissolution of the marriage by the decree of a court of competent jurisdiction, the community property, and the homestead, shall be assigned as follows:
* * * * * * *
Two. If the decree be rendered on any other ground than that of adultery or extreme cruelty, the community property shall be equally divided between the parties.

It is conceded that under the California law a wife’s interest in community property does not vest until a final decree of divorce has been entered and that she has a mere expectancy until that time. United States v. Robbins, 269 U. S. 315; 46 Sup. Ct. Rep. 148; Brown v. Brown, 170 Cal. 1; 147 Pac. 1168.

Guglielmi paid $12,000 and in consideration thereof his wife surrendered her expectant interest which the community property laws of the State of California gave her in the income which her husband would receive under his contract, whatever that income might be. Her expectancy arose through their marriage and the payment of $12,000 was a settlement between a husband and a wife in so far as the income from this contract was concerned. His pur- . pose in entering into the agreement was to make a definite settlement with his wife. The personal relationship between a husband and his wife is such that, when they decide to terminate that relationship and to divide their community property in California, neither of them can successfully contend that the transaction was entered into for profit within the meaning of the taxing statute here in question. The rights of this wife arose from the marriage, and the settlement of those rights by the husband is a personal expense to him, if it may be said to be an expense. See Gould v. Gould, 246 U. S. 151; Audubon v. Shufeldt, 181 U. S. 575; and Appeal of David G. Joyce, 3 B. T. A. 393. They had a division to make, and if one made this on favorable terms and the other on unfavorable terms, that one who lost is not thereby entitled to a deduction under section 214(a) (5) of the Revenue Act of 1921.

Judgment will be entered for the respondent.

Littleton concurs in the result only.


author: Lansdon:

text:
    Williams Brothers Aircraft Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3771.
    Promulgated February 9, 1927.
    Cost of intangible properties paid in for stock and tangible property paid in without consideration is not proved. Held, that failure to prove such cost is not evidence that invested capital can not be ascertained. Petitioner’s request for recomputation of tax liability under section 328 of the Revenue Act of 1918 is denied.

      Psrry W. Shrader, Esq., for the petitioner.

      D. D. Shepard, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income and profits taxes for the year 1919, in the amount of $632.06. The petitioner asks that its valuation of intangible assets, paid in for capital stock, be approved and considered in the computation of invested capital, together with tangible assets which, it alleges, had a value of $54,465 at the date they were paid in to the corporation by the stockholders thereof. If its invested capital can not be ascertained the petitioner asks for special assessment.
    FINDINGS OF FACT.
    The petitioner is a California corporation with its principal office at San Francisco, where it is engaged in the business of building and selling aeroplanes and accelerators for use on internal-combustion engines. It was incorporated on January 18, 1918, with authorized capital in the amount of $100,000, divided into 100,000 shares of the par value of $1 each. It is the successor of a partnership which previously, and at the same location, conducted a similar business under the name of Williams Brothers Manufacturing Co.
    At the date of its incorporation, the petitioner issued 55,020 shares of its capital stock to Emma F. Williams, for and on behalf of the partners of the Williams Brothers Manufacturing Co., and received therefor United States Patent bio. 1,014,194, covering an improved type of aeroplane, and the interest of the partnership in an invention described as an accelerator attachment for internal-combustion engines, for which an application for letters patent was then pending in the Patent Office of .the United States. At such date the patent and accelerator invention, together, had a value of $10,000.
    At the date of incorporation the members of the Williams Brothers Manufacturing Co. were Emma F. Williams, P. J. Williams, Chester L. Williams and Lloyd M. Williams, each owning an equal interest therein. Immediately after the incorporation of the petitioner and the issue of 55,020 shares of stock in exchange for the intangible property of the partnership, the stockholders and stock holdings thereof were as follows: Emma F. Williams, 25,000 shares; P. J. Williams, 10,000 shares; Chester L. Williams, 10,000 shares, and Lloyd M. Williams, 10,000 shares.
    Ón January 18, 1918, the stockholders of the petitioner, being all the members of the predecessor partnership, paid in to the corporation, without consideration, either in shares of stock or cash, the following enumerated articles of tangible assets: A heavy lathe; a power cut-oil saw; a cross-cut saw; a double spindle precision drill press; a Golden Gate gas engine; a large number of small tools, shafts, pulleys, belts, and hangars; a forge; a shop building, 3 partly completed aeroplanes; 6 models of aeroplanes; 5 small Curtiss motorcycle motors, and a quantity of drawings and blue prints used in the manufacture of the various articles which the petitioner was organized to produce. The value of the tangible assets so paid in was $30,000.
   OPINION.

Lansdon:

The issue here is solely as to the amount of invested capital to which the petitioner is entitled in the determination of its tax liability for the year 1919. Section 320(a) of the Revenue Act of 1918 provides that the term “ invested capital ” for any year means:

(1) Actual cash bona fide paid in for slock or shares;
(2) Actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment, but in no case to exceed the par value of the original stock or shares specifically issued therefor, unless the actual cash value of such tangible properly at the time paid in is shown to the satisfaction of the Commissioner to have been clearly and substantially in excess of such par value, in which case such excess shall be treated as paid-in surplus: * * *
(3) I’aid-in or earned surplus and undivided profits; * * *
*******
(5) Intangible property bona fide paid in for stock or shares on or after March 3, 1917, in an amount not exceeding (a) the actual cash value of such property at the time paid in, (b) the par value of the stock or shares issued therefor, or (e) in the aggregate 25 per centum of the par value of the total stock or shares of the corporation outstanding at the beginning of the taxable year, whichever is lowest * * *.

The petitioner was incorporated on January 18, 1918, with an authorized capital in the amount of $100,000. At the date of incorporation shares of the par value of $55,020 were issued in exchange for the interest of the predecessor partnership in two inventions which, we have found, had a cash value in the amount of $10,000 at that date. On the same date, the members of the predecessor partnership, who were the holders of the shares of the par value of $55,020, issued in exchange for the intangibles, paid in to the corporation without consideration in stock or cash certain tangible assets which, we have found, had a cash value of not less than $80,000 at that time.

Since 50 per cent or more of the stock of the Williams Brothers Aircraft Corporation remained in the hands of the persons who had constituted the predecessor partnership, the invested capital of the petitioner must be computed under section 331 of the Revenue Act of 1918 which provides:

* * * That ii such previous owner was not-a corporation, then the value of any asset so transferred or received shall be taken at its cost of acquisition (at the date when acquired by such previous owner) with proper allowance for depreciation, impairment, betterment or development * * *.

In his determination of the deficiency here asserted the Commissioner ascertained the invested capital of the petitioner. The evidence that the assets paid in for stock had a value in excess of. that allowed by the Commissioner is conclusivé and we have so found. The law, however, excludes such assets from invested capital except at their actual cost to prior owners. That cost has not been proved. The petitioner claims that if its invested capital can not be determined, it is entitled to special assessment. There is no showing that the invested capital of the petitioner can not be ascertained. The application for assessment under‘section 328 of the Revenue Act of 1918 is denied.

The evidence discloses that during the taxable year-the petitioner sold shares of its capital stock for cash in the approximate amount of $14,000. The amounts so paid in should be included in invested capital from the date or dates of such payment.

Judgment will be rendered on £0 days'1 no- ■ tice, wider Rule 50.


author: TeamMell :

text:
    Appeal of Pittsburgh-Northern Coal Co. Appeal of Girard Coal Co.
    Docket Nos. 2837, 3724.
    Promulgated February 10, 1927.
    1. On the evidence, corporations held to be affiliated.
    2. Value of coal land as of March 1, 1913, determined for depletion purposes.

      P. P. Campbell, Esq., and TI. B. McGawley, Esq., for the petitioners.

      P. J. Rose, Esq., for the Commissioner.

      These are appeals from deficiencies in income and profits taxes for 1919, in the amount of $1,793.65 for the Pittsburgh-Northern Coal Co., and $1,266.39 for the Girard Coal Co. The deficiencies result from the refusal of the Commissioner to allow depletion deductions as claimed by the petitioners and the refusal of the Commissioner to permit the petitioners and the Girard Fuel Co. to file a consolidated return as affiliated corporations under section 240(b) of the Bevenue Act of 1918.
    FINDINGS OF FACT.
    The Pittsburgh-Northern Coal Co. is a Missouri corporation, incorporated in 1909, with its principal office at Kansas City. Since its organization it has been engaged in mining and selling coal. The authorized capital stock of $75,000 was issued for the fee title to 240 acres of coal land in the Cherokee seam in Crawford County, Kansas, on which a mine had been sunk and development work had reached five or six hundred feet from the shaft, together with complete equipment necessary for the operation of the mine, subject to accounts payable incurred by previous owners in the amount of $67,700 which the petitioner assumed, and also subject to a first mortgage in the amount of $20,000 against the land. The consideration recited in the deed was $100 and other valuable considerations.
    Soon after the organization of the company 90 shares of stock were donated by three of the principal stockholders to the corporation, which were sold by it for $9,000 to provide a working capital. This stock was sold to employees of the company and some relatives of the principal stockholders. The coal land acquired by the petitioner is described as follows :
    The east half of the northwest quarter; the east half of the southwest quarter; the southwest quarter of the northeast quarter ancl the northwest quarter of the southeast quarter, except the railroad right of way, all in section 16, township 29, range 25, Crawford County, Kansas, aggregating 240 acres.
    After the acquisition of the above land by the petitioner, the petitioner, in July, 1909, leased an adjoining 240 acres of land of the same seam of coal, described as follows :
    The northwest quarter of the northeast quarter; the east half of the northeast quarter; the east half of the northeast quarter and the southwest quarter of the southeast quarter; all in section 16, township 29, range 25 east.
    These two tracts of land were contiguous and it was impracticable to segregate the coal mined from the petitioner’s property and that of the lessor, the coal coming through the same mine and being dumped into the same cars. To meet this condition and to simplify accounting for royalties, the petitioner and the lessor agreed that the character of the coal, the development, prospecting and production upon the above tracts would be about equal, and instead of paying the lessor 10 cents per ton for coal mined from his land, which was the agreed price, it was agreed that the petitioner would pay 5 cents per ton for all coal mined from both, tracts of land, and operations since the acquisition of the above lease have been conducted according to that agreement.
    The land to which the petitioner acquired the fee title had been bored and the petitioner had the drilling records which indicated that the vein of coal was about 39 to 40 inches thick and about 185 feet from the surface. There was other development work near this property.
    The tonnage on the two tracts was 1,080,000 tons. The average annual production was 80,000 tons, and the life of operations was 14 years.
    The petitioner valued the coal land, including the surface, at $60,000 at the time it was acquired for stock, and considered that to be the cost price for the purpose of depletion prior to March 1, 1913, and considered that price, less depletion sustained up to March 1, 1913, as being the value on that date for depletion allowances. The Commissioner determined that the cost of the coal was $20,100 and considered that figure, less depletion sustained, as the March 1, 1913, value.
    The coal mined from both the land owned in fee and that acquired by lease up to and including 1918 was as follows:
    Teal-. ' Tons.
    1909- 26,318.85
    1910- 39,266.10
    1911- 107,188.50
    1912- 103,257.20
    1913- 114, 992.75
    1914- 97, 583.10
    1915- 44, 720. 70
    1916- 120,859.90
    1917- 117, 966.00
    1918- 99,286. 00
    Total_ 871,439.10
    The tonnage remaining in place on January 1, 1919, was 208,500.9.
    The tonnage mined from the two tracts in 1919 was 78,090 tons. The two tracts were considered as one for the purpose of royalty settlements and no distinction was made between coal mined from one or the other. The 240 acres to which the title was acquired by the petitioner contained 540,000 tons and one-half of the coal mined during 1919 was mined from that tract. In determining the coal mined in the above tabulated statement, one-half is deemed to have been mined from the 240 acres owned in fee by the petitioner.
    The March 1, 1913, value of the coal in place on the 240 acres owned in fee was $28,000.
    The Girard Coal Co. is a Missouri corporation and the Girard Fuel Co. is. a Kansas corporation. These companies, together with the Pittsburgh-Northern Coal Co., were engaged in the same business. They occupied the same offices and had the same active managing officers and accountants. There was frequent interchange of monies without interest. The employees and equipment of the mines were frequently interchanged without charges. The expenses of the offices were arbitrarily divided between the companies according to their ability to pay. Coal was sold under a single contract made by Fleming.
    The following is a statement of the stock holdings of the three companies as of January 1, 1919, together with the relationship of the stockholders:

    I. M. Fleming was president, superintendent and general manager of the Pittsburgh-Northern Coal Co. He was vice president, superintendent and general manager of the Girard Coal Go. and the Girard Fuel Co. He at all times held power of attorney and voted the stock of Reid, Mrs. Pye and Hibben. He frequently voted the stock of Mrs. Willis Wood and Mrs. S. W. Harris. Coal produced by these companies was disposed of through one selling agency operaC ing in connection therewith.

      J. E. Crowe, Jr., and Maggie Crowe are the executors of the estate of J. E. Crowe, Sr., and they, together with one. daughter, are the beneficiaries under the will.
   OPINION.

TeamMell :

With respect to the depletion allowance for 1919, the question to be determined is what was the fair market value on March 1,1913, of the property acquired in 1909. Both the respondent and the petitioner considered that the March 1, 1913, value of the land acquired in fee was the cost price thereof less the depletion sustained up to that date. The respondent determined that the cost of this land was $20,100 upon • the evidence of the consideration recited in the deed. The' deed recited that it was executed in consideration of $100 and other valuable considerations, subject to a mortgage of $20,000 against the land, which was assumed. The land, however, was acquired in connection with a completed plant and mining equipment ready for operation. There were debts against the property -which had been incurred by the previous owners to the extent of $67,000, which the petitioner also assumed. The consideration recited in the deed was not the actual consideration paid. The land, together with equipment, machinery and other assets, with the encumbrances against the property was in fact acquired for stock. The petitioner considered that $60,000 of the total purchase price was for the land and that the balance was for equipment, fixtures and other things which made up the completed plant. That amount was placed upon the books of the petitioner as cost of the land.

There is no evidence as to the value of the items of equipment, nor any evidence by which an allocation may be made between the cost of land and other assets.

From all the evidence, it is our opinion that the value on March 1, 1913, of the coal in place on the 240 acres of land owned by the petitioner in fee was $28,000. The depletion allowance for 1919 should be determined on that basis.

The other controversy in this appeal is whether the Pittsburgh-Northern Coal Co. and the Girard Coal Co. were, during the year 1919, affiliated within the provision of section 240 of the Eevenue Act of 1918, and entitled to file a consolidated return. These companies were organized and operated by a group of persons who were closely associated in business relations or by family ties. Fleming was the principal directing force in all of them. Fleming, Crowe, Sr., Gray, and Buchanan had been associated in several mining ventures over a period of many years.

The greatest divergency in stock ownership exists in the Crowe estate and members of the Crowe family, two of whom were the beneficiaries of that estate.. The two members of the Crowe family were executors of the estate and as such were in control of the stock owned by the estate. J. K. Crowe, Jr., held in trust for his sister 14% per cent of the stock of the Pittsburgh-Northern Coal Co. and was one of the executors of the estate which owned stock in both the other corporations.

Gray was an employee of the Crowe estate. Miller was an employee of all the corporations. Mrs. Pye was Fleming’s mother-in-law. Mrs. Harris was Miller’s sister-in-law. Fleming at all times voted the stock of Miller, Reid and Mrs. Pye.

From all the evidence, we are of the opinion that the stock in all three of the companies was owned or controlled by the same interests. The corporations are, therefore, affiliated and are entitled to file a consolidated return for the year involved.

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