The opinion
AMERICAN GUT STRING MANUFACTURING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
American Gut String Mfg. Co. v. Commissioner
Docket No. 20422.
United States Board of Tax Appeals
19 B.T.A. 608 ; 1930 BTA LEXIS 2366 ;
April 16, 1930 , Promulgated
*2366 Conditions not found to exist with respect to petitioner's invested capital and/or income for 1920 which bring it within the provisions of section 327, Revenue Act of 1918.
John E. Hughes, Esq., for the petitioner.
Hartford Allen, Esq., for the respondent.
SEAWELL
*609 This proceeding involves a deficiency in income and profits tax as determined by the Commissioner for 1920 in the amount of $1,791.17, and the sole question to be decided under the present hearing is whether the situation existing with respect to petitioner's invested capital and/or income is such that would bring it within the provisions of section 327 of the Revenue Act of 1918 and entitle it to have its profits tax computed under the provisions of section 328 of the same act.
FINDINGS OF FACT.
The petitioner is an Illinois corporation, with its office and principal place of business in Chicago.
The petitioner is the successor to a business carried on from 1910 to 1912 by Harry L. Diehl, who is and has been since its formation the president, general manager, treasurer and sole stockholder of the petitioner. Upon incorporation in 1912, the capital stock of a par value *2367 of $10,000 was issued for the tangible and intangible assets of the predecessor business in the respective amounts of $9,500 and $500.
The business of the petitioner is the making of gut strings, which are used for surgical, musical and athletic purposes. Prior to 1912 and for some time thereafter most of the surgical gut used in this country came from Germany, since from a cost standpoint it was difficult for the concerns in this country to compete with the foreign producers.
Gut strings are made largely from the intestines of sheep and hogs, the former being used for the manufacture generally of surgical gut strings, and the latter for the manufacture of strings for athletic and musical purposes. Prior to 1915 gut strings were made by splitting a tubular intestine into two ribbons or parts, but in 1915 Diehl made application for a patent under which the intestine could be split into three parts. This patent was granted in 1917. As a result thereof, the usable value of the raw material was increased approximately 50 per cent in that three ribbons or strings could be made where two were made formerly. Much material which formerly was waste in the manufacture of surgical *2368 gut could be used for that purpose, and the products were of a higher grade than those which were previously manufactured therefrom. In addition, a higher quality of string and one of greater strength could be produced since the narrower ribbons permitted a greater number to be used in a single string.
The profits of the petitioner were due in large measure to the use of the foregoing patented device - particularly in the surgical-gut business, which constituted approximately 60 per cent of its *610 profits, but also in its other lines. As a result of this patented device, it was enabled to secure from one of its competitors the business of the largest manufacturer of suture material and a concern which took about three-fourths of petitioner's surgical gut. Further, through the saving in raw material, petitioner was better able to compete with foreign producers. Several concerns failed which attempted to carry on a similar business without a patent of this character.
While the patent in question was issued to Diehl, petitioner's president and sole stockholder, and never assigned to the petitioner, it was used by the petitioner without the payment of royalties therefor *2369 other than that in the payment of a salary of $15,000 to Diehl consideration was given to the ownership by him of this patent which was being used by the petitioner without the payment of royalties. In addition to the positions heretofore enumerated as being held by Diehl with petitioner, Diehl directed both the manufacturing and sales ends of the business.
Another important factor in the success of petitioner's business in 1920 was the development prior thereto of certain secret chemical processes which were used in petitioner's business. These processes were developed by petitioner's president with the assistance of factory employees and the expenditures were borne by the petitioner. No amount was capitalized on account of such expenditures, and because of the system of accounting employed by the petitioner it is impossible to determine accurately the amount thereof, though such amount was less than $10,000.
The petitioner's gross sales for 1920 as shown by its return were $135,532.29 and its gross income was $40,233.13. Net income amounted to $26,750.25, and statutory invested capital as determinable, was $46,094.29.
In the determination of the deficiency in question *2370 the profits tax has been computed under the provisions of section 302 of the Revenue Act of 1918, and when so computed amounts to $6,100, which is less than that determinable under section 301 of the same act.
OPINION.
SEAWELL: The one question presented under the present hearing in this proceeding is whether conditions existing in 1920 with respect to petitioner's invested capital and/or income are such as would bring it within the provisions of section 327 of the Revenue Act of 1918, and thus entitle it to whatever benefit might be afforded by a computation of its profits tax under the provisions of section 328 of the same act. The contention most strongly urged upon us by the petitioner in support of its claim that special assessment should be *611 allowed is that under section 327(a) of the Revenue Act of 1918, where the Commissioner is unable to determine the invested capital as provided in section 326, it is mandatory to give the taxpayer whatever relief may be afforded by a computation under section 328 of the same act. That is, if we understand the petitioner correctly, regardless of how small or trivial the amount of invested capital may be which is not determinable, *2371 special assessment would follow as a matter of course. We can not agree that such a result is intended or required by the statute. To carry petitioner's argument to its logical conclusion would almost certainly mean that the greater number of corporations which have been in existence for several years would be entitled to the benefit of the special assessment provisions, for the reason that it would be exceptional to find a corporation with such a complete system of accounting that everything of a capital nature, whether tangible or intangible, had been properly capitalized or could be determined with absolute accuracy. In the case at bar there were certain development expenses which were not capitalized, but the petitioner made no attempt to show what they amounted to. It was only on cross-examination that the maximum figure of $10,000 was suggested by Commissioner's counsel and petitioner's president said it was "considerably less than that." He further stated that they "were not making heavy expenditures for development work" and that the amount named "would cover it amply." In view of the foregoing and when the relief already granted by section 302 is considered, we are of *2372 the opinion that the application of the special assessment provisions is not shown to be required on account of the failure to capitalize the development expenses in question. Cf. .
The further contention is advanced that an abnormality affecting both income and invested capital exists because of the use by the corporation of a patent which was not owned by the corporation and for the use of which the corporation did not pay royalties. Royalties as such were not paid by the corporation for the use of the patent, but when petitioner's president, who was the owner of the patent, was asked whether consideration was given to the use of his patent in fixing his salary of $15,000, his reply was, "Undoubtedly." We think it is established that the use of the patent by the corporation was a material aid in the production of income, but we are not satisfied that evidence has been produced which would enable us to say that an abnormality exists, either as to invested capital or income, on account thereof.
Reviewed by the Board.
Judgment will be entered for the respondent.