#### HOPE FORGE & MACHINE CO. v. THE UNITED STATES

[No. E-549.

Decided December 5, 1927]

*On the Proofs*

*Income and, excess-profits taxes; contracts and good will as invested capital.*— The cash value oí contracts and good will determined by the court and allowed as invested capital in computation of plaintiff’s income and excess-profits taxes for 1917-1920. Section 207, revenue act of 1917.

*The Reporter's*statement of the case :

*Mr. 8. Leo Ruslander*for the plaintiff. *Mr. Samuel Kaufman*was on the brief.

*Mr. Geot'ge H.*Foster, with whom was *Mr. Assiistcmt Attorney General Kerman J.*Galloway, for the defendant.

The court made special findings of fact, as follows:

I. The plaintiff was and is a corporation duly organized under and existing by virtue of the laws of the State of Ohio, with its ¡irincipal office and place of business in the city of Mount Vernon, Ohio.

II. Plaintiff duly filed its income and excess-profits tax returns for the years 1917, 1918, 1919, and 1920 and paid to the collector of the 11th district of Ohio the sums of $2,668.95, $6,223.57, $1,981.40, and $3,373.35, respectively, the amounts shown to be due in the returns for the said respective years.

III. The basis of this suit is the exclusion by the Commissioner of Internal Eevenue on subsequent audit of said returns of the total value of certain contracts and good will from invested cap.ital for each of the years 1917,, 1918, 1919, and 1920 and the assessment and collection of the additional taxes resulting from such action.

*333IY. On notice of said proposed additional assessments of income and profits taxes plaintiff duly protested, and its appeal was denied by the committee on appeals and review on May 12, 1923.

V. Thereafter plaintiff received not-ices and demands for payment of said additional taxes for the years 1917, 1918, 1919, and 1920 in the amounts of $543.67 for 1917; $3,421.96 for 1918; $735.13 for 1919; and $735.69 for 1920, and paid said additional taxes under protest on October 13, 1923.

VI. On or about September 11, 1924, plaintiff duly filed with the Commissioner of Internal Bevenue a claim for refund of said $5,436.45, covering said .income and excess-profits taxes claimed to have been illegally and wrongfully collected from plaintiff for the years 1917 to 1920, both inclusive, as follows: $543.67 for 1917, $3,421.96 for 1918, $734.13 for 1919, and $735.69 for 1920. The commissioner has to date rendered no decision thereon.

VII. Plaintiff was organized March 6, 1914, with an authorized capital of $200,000.00, in pursuance of a written agreement, dated March 6, 1914, copy of which is attached to the petition as Exhibit 1 and made a part hereof by reference, between P. S. Kelser and the Hope Engineering and Supply Company, a Pennsylvania corporation. By ■ the terms of said agreement said P. S. Kelser, to whom all the property, both tangible and intangible, of the Beeves Engineering Company, a then existing corporation, was to be conveyed, was to convey to plaintiff corporation all of the said property, together with $12,000 in cash for certain stock in said new company. Of the common stock issued by the company five-ninths was to be issued to the Hope Engineering and Supply Company, which company was to pay to the new corporation $25,000 in cash, less certain credits, as well as to make w,ith plaintiff certain contracts.

VIII. On April 1, 1914, the said Hope Engineering and Supply Company entered into a written agreement with plaintiff under the terms of which said Hope Engineering' and Supply Company agreed to use its best endeavors to sell the products, which plaintiff was to manufacture.

IX. The Hope Engineering and Supply Company had in 1914 been engaged ,in the business of acting as consulting and. *334contracting engineers since 1906. In 1914 it was in a position to recommend, through its sales department, plaintiff’s products, which recommendation facilitated the sale thereof with much less sales expense than if plaintiff had maintained .its own sales organization.

X. On April 1, 1914, the Hope Engineering and Supply Company effected an agreement between plaintiff and the Hammon Coupler Company, under the terms of which plaintiff was to manufacture couplers for the Hammon Coupler Company on a cost plus 10 per cent basis. The Hammon coupler was well known in the natural-gas industry in 1914, there had been large sales of said coupler prior to 1914, and said contract was expected to and did enable plaintiff to operate a department regularly without sales expense.

XI. By bill of sale dated March 6, 1914, the said P. S. Kesler conveyed to plaintiff all of the property of the said Beeves Engineering Company.

XII. The board of directors of the Hope Forge & Machine Company, by resolution dated March 6, 1914, declared that all of the property and rights acquired by it, as set out in these findings, were of the value of at least $200,000, and caused capital stock to be issued in that amount, $30,000 preferred and $170,000 common. Five-ninths of said common stock was issued to the Hope Engineering and Supply Company. A copy of this resolution is attached to the petition as Exhibit 5 and made a part hereof by reference.

XIII. Of the total of $200,000 capital stock issued, $38,733.00 was issued for cash at a par value of $100 per share.

XIV. The opening entries in the books of account of plaintiff, made when plaintiff originally issued its stock as aforesaid and authorized by its board of directors, show that said $200,000.00 stock so issued was issued for cash, the tangible assets of the Beeves Engineering Company, the contracts with the Hope Engineering and Supply Company and the Hammon Coupler Company, and the good will of the Beeves Engineering Company and so much thereof of the Hope Engineering and Supply Company and Hammon *335Coupler Company as was acquired under said contracts, in the following amounts:

Cash____$33, 733.00

Contracts_ 40,000.00

Net tangible assets of Beeves Engineering Co- 66,020. 21

Good will_ 60, 246. 79

200, 000. 00

The total capital stock of plaintiff outstanding on Match 3, 1917, was $176,037.50; twenty per cent thereof is $35,-207.50, and twenty-five per cent thereof is $44,009.38.

XY. From November 22, 1921, to December 3, 1921, an agent of the Internal Revenue Bureau made an investigation of the income and profits-tax liability of plaintiff for the years 1917 to 1920, inclusive, and in his report made December 3, 1921, allowed said contracts and good will to be included in invested capital for 1917 in the sum of $35,207.50, and for each of the years 1918, 1919, and 1920 in the sum of $44,009.38. These amounts were arrived at by applying the statutory limitation by which the amount included in invested capital for intangibles was for 1917 limited to 20% of the outstanding capital stock on March 3, 1917, and for 1918, 1919, and 1920, 25%.

The said report was made to the internal-revenue agent in charge at Cincinnati, Ohio, and was by him approved and transmitted on or about December 3,1921, to the Deputy Commissioner of Internal Revenue at Washington, D. C., in charge of the Income Tax Unit.

There is no evidence of any other investigation or report of plaintiff’s tax liability in this ease by the defendant.

XVI. The combined actual cash value of the said contracts and good will ,so entered in the books of account was for the year 1917, $35,207.50, and for each of the years 1918, 1919, and 1920, $44,009.38; and said value did not exceed the actual cash value at the time of purchase.

‘If plaintiff was entitled to include in invested capital the contracts and good will aforesaid, or either, for 1917 in the sum of $35,207.50, and for each of the years 1918, 1919, and 1920 in the sum of $44,009.38, it is entitled to a refund of $5,436.45, the amount claimed by it.

*336The court decided that plaintiff was entitled to recover $5,436.45, with interest from October 13, 1923, to date of judgment, a total of $6,788.31.

Geaham, Judge,

delivered the opinion of the court:

Plaintiff filed its income and excess-profits tax returns for the years 1917, 1918, 19Í9, and 1920, and paid to the Government the amounts shown by the returns to be due for those years. Thereafter the plaintiff recéived notice of a proposed additional assessment of income and excess-profits taxes based upon an audit of said returns, which excluded the total value of certain contract^ and good will from invested capital for each of said years. Plaintiff paid under protest the additional taxes in the sum of $5,436.45, and on or about September 11, 1924, it filed a claim with the Commissioner of Internal Revenue for a refund of that amount. *The*Commissioner having failed to *render*a decision *within*six months, suit was brought in this court.

Prior to the levying of the additional assessment the Internal Revenue Bureau, through' one of its agentjs, made an investigation of the income and excess-profits tax liability of the plaintiff for the said years, and in his report allowed such contracts and good will to be included in the invested capital for the year 1917 in the sum of $35,207.50, and for each of the years 1918, 1919, and 1920 in the sum of $44,009.38. These amounts were arrived at by applying the statutory limitation by which the amount included in the invested capital for intangibles was for 1917 limited to 20 per cent of the outstanding capital stock on March 3, 1917, and for 1918, 1919, and 1920, 25 per cent. This report was forwarded to the Commissioner of Internal Revenue at Washington, D. C.

The only question raised at the hearing of this case was the cash value of the contracts and good will.

Sec. 207 of the revenue act of 1917, 40 Stat. 800, defines invested capital and what shall be included therein as follows:

“(b) The good will, trade-marks, trade brands, the franchise of a corporation or partnership, or other intangible property shall be included as invested capital if the corpora*337tion or partnership made payment bona fide therefor specifically as such in cash or tangible property, the value of such good will, trade-mark, trade brand, franchises, or intangible property not to exceed the actual cash or actual cash value of the tangible property paid therefor at the time of such payment ; but good will, trade-mark, trade brands, franchise of a corporation or partnership, or other intangible property bona fide purchased prior to March third, nineteen hundred and seventeen, for and with interest or shares in a partnership or for and with shares in the capital stock of a corporation (issued prior to March third, nineteen hundred and seventeen) , in an amount not to exceed ,on March third, nineteen hundred and seventeen, twenty per centum of the total interests or shares in the partnership or of the total shares of the capital stock of the corporation, shall be included in invested capital at a value not to exceed the actual cash value at the time of such purchase, and in case of issue of stock therefor not to exceed the par value of such stock.”

The court has found that the cash value of the contracts and good will for the year 1917 was $35,207.50, and for each of the years 1918,1919, and 1920 was $44,009.38. The plaintiff is therefore entitled to judgment for the taxes paid on account of the additional assessment, aggregating $5,436.45,. with interest, and it is so ordered.

Moss, *Judge;*Booth, *Judge;*and Campbelu, *Ohief Justicer*concur.