Electric Appliance Co. v. Commissioner

ELECTRIC APPLIANCE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Electric Appliance Co. v. Commissioner

Docket No. 28543.

United States Board of Tax Appeals

19 B.T.A. 707 ; 1930 BTA LEXIS 2339 ;

April 25, 1930 , Promulgated

*2339 1. There was no error in the Commissioner's action in excluding from petitioner's invested capital $100,000 original capital stock for which nothing was paid by those to whom the stock was issued.

2. SPECIAL ASSESSMENT. - The fact that a corporation was enabled to carry on its business with less capital than would have been required had it not had the benefit of a favorable arrangement with another corporation is no ground for special assessment when it appears that the capital as used in its business and recognized for statutory invested capital purposes is not other than normal for a business so carried on. Moses-Rosenthal Co., 17 B.T.A. 622 ; Coca-Cola Bottling Co. of Pittsburgh, 19 B.T.A. 267 .

3. INVESTED CAPITAL - TAX DEDUCTIONS. - Invested capital should not be reduced by taxes of prior years which have been abated or barred by limitation, but should be proportionately reduced by taxes for previous year when such tax becomes due and payable.

George E. H. Goodner, Esq., for the petitioner.

T. M. Mather, Esq., for the respondent.

BLACK

*707 Petitioner seeks redetermination of deficiencies of $691.89 *2340 for the fiscal year ending November 30, 1919, and $3,171.45 for the fiscal year ending November 30, 1920, and alleges (1) erroneous disallowance of special assessment under sections 327 and 328, Revenue Act of 1918; (2) erroneous exclusion from invested capital of the value of good will and intangible assets; (3) erroneous reduction of invested capital by alleged additional taxes for prior years, which were abated or barred by limitation; (4) erroneous reduction of invested capital each year by the tax for the prior year prorated from the date of payment.

FINDINGS OF FACT.

About 1892 the Electric Appliance Co. of Chicago, an Illinois corporation, began the sale of its electrical supplies in the territory west of the Rocky Mountains in the Pacific Coast States and in parts of Mexico and Canada. It did this by traveling salesmen and by advertising extensively by printed catalogue and newspaper advertising. The business in this territory prospered and by 1904 amounted to approximately $250,000 annually. On account of competition it was deemed advisable to establish a branch house in San Francisco and this was done in 1904. Due to California laws and other considerations, it *2341 was afterwards determined to incorporate the San Francisco branch and this was done April 22, 1905, under the name of petitioner.

*708 The capital stock was fixed at $100,000, divided into 1,000 shares of $100 par value each, of which 400 were issued to W. W. Low, president of the Chicago company, 400 shares to Thomas I. Stacey, secretary and treasurer of the Chicago company, 100 shares to F. J. Cram, 95 shares to C. C. Hillis, and 5 shares to Mrs. C. C. Hillis. Cram and Hillis had been connected with the San Francisco branch and traveled that section for several years. No money was paid for the capital stock, but an asset entry was made on the books of "Business Rights & Agencies, $100,000." No agency contracts, business rights, or other intangible assets were conveyed to petitioner by the stockholders in payment for their shares of stock.

The Chicago corporation withdrew from the Pacific Coast territory and left that territory to petitioner, and petitioner thereby succeeded to the good will and going business which the Chicago corporation had theretofore established in that territory. It took over the business, customers, and assets of the Chicago corporation in that *2342 territory and assumed the liabilities of the branch. The Chicago corporation loaned petitioner $5,000 to meet initial expenses.

Petitioner's business was conducted largely on the credit of the Chicago house, which frequently guaranteed its accounts and endorsed its notes for borrowed money. The Chicago house shipped goods to petitioner at cost plus a small handling charge, which enabled it to acquire and have on hand large quantities of material, which it could not have otherwise done. Through the credit of the Chicago house it was enabled to purchase on long time payments and on consignment, which enabled it to dispose of the goods before payment. Petitioner received the benefit of advertising done by the Chicago house both before and after its incorporation as petitioner's business was always featured.

Petitioner's business prospered, and reasonable salaries and dividends were paid until 1920, when a surplus of approximately $150,000 had been accumulated.

The respondent determined petitioner's net income and invested capital for the taxable years as follows: year ending November 30, 1919, income $28,373.71, invested capital $132,031.79; year ending November 30, 1920, income *2343 $61,621.60, invested capital $137,607.34. In making this determination respondent did not include in invested capital anything for the $100,000 capital stock of petitioner for either year.

Respondent further reduced invested capital for 1919 by deducting therefrom $16,357.03 additional taxes for 1917, and by $12,415.36 proportionate part of additional tax for 1918.

In computing invested capital for 1920 respondent made a reduction of $16,357.03 on account of 1917 taxes, $20,482.12 on account of 1918 taxes, and $2,585.40 proportionate part of 1919 taxes. Petitioner *709 paid the taxes assessed on its returns for 1917 and 1918 and the taxes above mentioned for 1917 or 1918 were additional taxes. Of these $4,461.97 were abated for 1917 and $6,367.88 for 1918 and the balances for the two years were both held barred by the statute of limitations by this Board in Electric Appliance Co. v. Commissioner, Docket No. 17870, by order entered October 26, 1928, which was after the determination of the deficiencies herein.

No evidence as to the value of the arrangements between petitioner and the Chicago company other than the book entries and history of petitioner has *2344 been introduced. These arrangements were valuable and an important and substantial factor in the production of petitioner's income.

By order of the Board the hearing was limited to the issues defined in subdivisions (a) and (b) of Rule 62.

OPINION.

BLACK: One of the errors alleged by petitioner is the exclusion from invested capital of the value of good will and intangible assets acquired by it from the Chicago corporation. Although we are convinced that they were of substantial value in the production of business and income, there is no evidence that they were a part of petitioner's invested capital under the statutes. It is perfectly true that section 325 provides for the inclusion in invested capital of intangibles but paragraph (4) of said section provides that such intangibles must have been bona fide paid in for stock.

The Electric Appliance Co. of Illinois owned no stock of petitioner and received nothing for whatever good will and intangibles it may have transferred to petitioner. The capital stock of petitioner was not issued to the Electric Appliance Co. of Illinois, but was issued to W. W. Low, Thomas I. Stacey, F. J. Cram, C. C. Hillis, and Mrs. C. C. Hillis, *2345 as individuals and not as nominees of the Illinois corporation, and there is no evidence to show that they paid in anything for the stock or transferred to the corporation any good will, agency contracts, or other valuable rights in payment therefor. Under such circumstances the action of the respondent in excluding this $100,000 original capital stock from invested capital was correct and his action in that respect is approved.

Petitioner in its appeal alleges as error disallowance of special assessment under sections 327 and 328, Revenue Act of 1918.

Section 327 enumerates in paragraphs (a), (b), (c), and (d) the several grounds which will entitle the taxpayer to have its taxes computed under section 328. The only possible one of these paragraphs which petitioner could claim as fitting its case would be paragraph (d). That paragraph provides that where there are abnormal conditions *710 affecting the capital or income of the corporation such as to work upon the corporation an exceptional hardship evidenced by gross disproportion between the tax computed without benefit of the special assessment section and the tax computed by reference to the representative corporations *2346 specified in section 328, it will be entitled to special assessment. Clearly, in this case there is no abnormality in invested capital. Nothing was paid in for the original $100,000 capital stock. The action of petitioner in setting up on its books "Business Rights and Agencies $100,000" was purely arbitrary. As we have heretofore stated, the Electric Appliance Co. of Illinois received no stock in petitioner corporation and its assistance and help to petitioner, though valuable, was not a part of petitioner's invested capital.

Petitioner had accumulated a considerable earned surplus in its business and that was properly allowed by respondent as invested capital in the taxable years. The only error that respondent committed in that respect was to exclude from invested capital certain additional taxes which were either abated or the Board has held to be barred by the statute of limitations. That error will be discussed later in this opinion.

The facts in the instant case are distinguishable from those in the cases of ; *2347 ; , and other cases.

These were all cases where valuable intangibles were actually transferred in payment for capital stock and the Board was able from the evidence to find the value of such intangibles. These cases are not applicable to the instant case.

Now, was there such abnormality in petitioner's income as to entitle it to special assessment? We think not. In the case of , we held that the fact that a corporation was enabled to carry on its business with less capital than would have been required had it not had the benefit of a favorable contract arrangement with another corporation is no ground for special assessment when it appears that the capital as used in its business and recognized for statutory invested capital purposes is not other than normal for a business so carried on. To the same effect was our holding in the recent case of . In that case we said: "Where the full capital which is invested in the business and which is necessary *2348 for its operation is recognized for invested capital purposes, we do not think an abnormality exists because there has not been taken into consideration a value which may attach to the contract under which the profits were realized, but which represents no investment on the part of the petitioner." The instant case is practically *711 identical with , and we think that case states the correct rule. Respondent's action in denying special assessment under sections 327 and 328 is approved.

The reduction of invested capital by the additional taxes assessed for 1917 and 1918 was unauthorized, as a part thereof was abated and the balance for both years was held barred by limitation by this Board in Docket No. 17870. Under these circumstances these outlawed taxes can not be deducted from invested capital and should be restored to invested capital in determining the deficiencies here. .

It does not appear to us that error was committed by the respondent by prorating the tax paid for 1917 and 1918 and reducing invested capital accordingly, and his action relative *2349 thereto is approved. .

Judgment will be entered under Rule 50.