Court Opinion

ID: 4599169
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:22:48.308146+00
Date Added: 2024-06-11T07:52:04.741056
License: Public Domain

ENAMELED METALS CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Enameled Metals Co. v. CommissionerDocket No. 19011.United States Board of Tax Appeals14 B.T.A. 1392; 1929 BTA LEXIS 2950; January 17, 1929, Promulgated 1929 BTA LEXIS 2950">*2950  1.  Petitioner held not to be entitled to compute its profits tax under section 328 of the Revenue Act of 1918.  2.  A taxpayer does not establish that it is impossible to compute its invested capital by proving that certain items have been improperty excluded.  3.  The inability of a taxpayer to include in its invested capital an asset which is used in its business does not result in an abnormality in capital within the meaning of section 328 of the Revenue Act of 1918 unless such exclusion causes exceptional hardship.  4.  No abnormality resulted from the affiliation of the petitioner corporation with other corporations where petitioner did not suffer by reason of such affiliation.  Quaere: Whether the affiliation of two or more corporations could ever create an abnormality with respect to any one of them.  S. Leo Ruslander, Esq., for the petitioner.  H. LeRoy Jones, Esq., for the respondent.  PHILLIPS 14 B.T.A. 1392">*1393  The Commissioner determined and assessed additional income and profits taxes against petitioner for 1918 in the amount of $66,920.09.  Petitioner filed a claim for the abatement thereof which the Commissioner allowed to the1929 BTA LEXIS 2950">*2951  extent of $34,513.66 and denied in the amount of $32,406.43.  The petitioner instituted this proceeding for a redetermination of its liability for such taxes, alleging that it is entitled to a computation of its profits tax for 1918 under sections 327 and 328 of the Revenue Act of 1918.  Pursuant to an order of the Board the issue was limited in the first instance to the issues set out in subdivisions (a) and (b) of Rule 62 of the Roard's rules of practice.  FINDINGS OF FACT.  The petitioner is a corporation organized under and existing by virtue of the laws of the State of Pennsylvania.  Petitioner is, and was during 1917 and 1918, engaged in the business of making rigid iron conduits for electrical wires.  The Pittsburgh Can Co., engaged in the business of making cans and containers, and the Pittsburgh Gallery Brick Co., engaged in the business of making bricks, were subsidiary companies owned by petitioner in 1917 and 1918, and were included in the consolidated income and profits-tax returns filed by petitioner for those years.  The Commissioner determined that petitioner had a taxable net income for 1918 of $100,984.70; that the taxable net income of the Pittsburgh Can Co. 1929 BTA LEXIS 2950">*2952  was $11,472.54 and that the Pittsburgh Gallery Brick Co. had a loss of $15,384.24.  He determined the net taxable income of the affiliated group to be $97,073 and its invested capital to be $337,374.95.  In computing such consolidated invested capital, the earned surplus of the petitioner was reduced by the operating deficits of its affiliated companies in the amount of $22,252.96.  During 1918 petitioner occupied its plant under a lease from Spang-Chalfant & Co., the terms of which were as follows: ARTICLES OF AGREEMENT entered into this first day of November, A.D.  One thousand nine hundred and twelve (1912), between SPANG, CHALFANT & CO., Inc., a corporation organized and existing under the laws of the State of Pennsylvania, first party (hereinafter called the "Lessor"), and ENAMELED METALS COMPANY, a like corporation, second party (hereinafter called the "Lessee"), WITNESSETH:  - That the Lessor hereby leases to the Lessee for the term of twenty (20) 14 B.T.A. 1392">*1394  years, commencing on the first day of November, A.D. 1912, for the total rent of Thirty-six thousand ($36,000) Dollars, lawful money of the United States, payable at the office of the Lessor in monthly installments1929 BTA LEXIS 2950">*2953  of One hundred and fifty ( $150) Dollars each: that is to say, One hundred fifty ( $150) Dollars on the first day of November, A.D. 1912, and a like sum on the first day of each month following during the said term:  - ALL that certain tract of land situate in the Borough of Etna, County of Allegheny and State of Pennsylvania, containing Sixty-two thousand sixty-six (62,066) square feet, and now occupied by certain buildings of the Lessee, as is more particularly shown on the plan attached hereto and made part hereof.   - AND THE PARTIES HERETO COVENANT AND AGREE AS FOLLOWS, to wit:  - FIRST.  The Lessee shall pay the said rent in cash at the office of the Lessor in the City of Pittsburgh as the installments shall fall due as hereinbefore provided; and the Lessee shall use the leased premises principally for the manufacturing of conduit from wrought iron or steel pipe, and shall not assign or transfer this lease or any part thereof, nor underlet the said described or demised premises, or any portion thereof, without the written consent of the Lessor.   - SECOND.  IT IS UNDERSTOOD that all of the buildings, structures, machinery, equipment and appliances erected, constructed1929 BTA LEXIS 2950">*2954  and placed on the leased premises are the property of the Lessee, and that at the expiration of the said term of 20 years, or any earlier termination of the estate of the Lessee by reason of its failure to manufacture conduit from wrought iron or steel pipe, as provided in paragraph 3 hereof, the Lessee may, at its option, at any time within a period of ninety days immediately following the expiration or earlier termination of said term for the cause herein set forth, remove from the said premises any and all such buildings, machinery, equipment and appliances erected, constructed and placed thereon by the Lessee; provided, however, that the Lessee shall have faithfully performed and kept all of the covenants and agreements herein appearing.   - THIRD.  In the event that the Lessee should permanently cease the manufacture of conduit made from wrought iron or steel pipe, this lease shall terminate as of the date of such permanent cessation of manufacture, in the same manner as though the full term of twenty (20) years had expired; BUT IT IS EXPRESSLY UNDERSTOOD AND AGREED that in the event of a termination of this lease for any reason or cause other than the expiration of the said1929 BTA LEXIS 2950">*2955  full term of 20 years, or the earlier termination hereof due to the failure of Lessee to continue the manufacture of conduit as stipulated in this paragraph, the Lessee shall not be entitled to the privilege of removing any of the buildings, structures, machinery, equipment and appliances from the leased premises, but the same shall become the property of the Lessor, notwithstanding anything herein to the contrary.   - FOURTH.  The lessor shall, so long as this lease shall be in full force and effect, sell to the Lessee such wrought iron or steel pipe as the Lessee shall require in its business at the fair market value thereof; and the Lessee covenants and agrees to purchase from the Lessor, and from no other party, all wrought iron or steel pipe which it, the Lessee, may require in its business of manufacturing conduit and which the Lessor may be able to furnish.   - FIFTH.  The Lessor shall not manufacture conduit in competition with the Lessee during the time that this lease is in full force and effect, but nothing contained herein shall be construed so as to prevent the Lessor from selling any raw pipe to parties other than the Lessee for the manufacture of 14 B.T.A. 1392">*1395  conduit, 1929 BTA LEXIS 2950">*2956  whether such third parties are competitors of the Lessee or not, provided only that the Lessor tenders to the Lessee from time to time the same quotations on raw pipe tendered by Lessor to its most favored customers.   - SIXTH.  Should either party to this lease sell or assign its business or plant with or without the consent of the other party hereto, IT IS AGREED that such party so selling or assigning shall preserve to the other party the letter's rights hereunder, particularly those appearing in Paragraph "Fourth" hereof.   - SEVENTH.  The Lessee shall pay any and all taxes that may be levied or assessed during the said term, beginning with January 1st, 1912, upon the said demised premises, and the buildings, structures, machinery, equipment and appliances erected, constructed, and placed thereon.   - EIGHTH.  If the Lessee shall default in the payment of any installment of rent provided for under this lease as the same become due and payable, or shall at any time hereafter become embarrassed or make an assignment for the benefit of creditors, or bankruptcy proceedings be begun by or against the said Lessee, or it be sold out by virtue of any legal process, or shall remove1929 BTA LEXIS 2950">*2957  or attempt to remove, its property from said premises other than is necessary in its business, then and in such case the entire rent for the balance of the said term shall at the option of the Lessor at once become due and payable as if by the terms of this lease it were all payable in advance, and shall be first paid out of the proceeds of such assignment or sale, any law usage or custom to the contrary notwithstanding.   - NINTH.  In case of any breach or non-performance of any of the covenants, conditions or requirements of this lease which on the part of the Lessee are to be performed, fulfilled and kept, the Lessor may at its option give to the Lessee notice in writing that unless the said covenant, condition or requirement shall be performed within sixty (60) days thereafter, this lease shall be forfeited and determined; and at the expiration of the said sixth (60) days, unless the said covenant, condition or requirement shall have in the meantime been performed, this lease shall be and become absolutely void and of no effect, and it shall and may be lawful for the Lessor to at once re-enter and take possession of the said described and leased premises, and of the buildings, 1929 BTA LEXIS 2950">*2958  structures, machinery, equipment and appliances erected, constructed and placed thereon, without compensation therefor to the Lessee, so as to vest the title to the said described and leased premises, and the buildings, structures, machinery, equipment and appliances in the Lessor, with like effect as if the Lessor had at its own cost erected, constructed and placed all of the said buildings, structures, machinery and equipment and appliances and had never leased the said premises.  IT BEING, HOWEVER, UNDERSTOOD that neither such forfeiture and re-entry, or either of them, shall preclude the Lessor from proceeding to recover any rent due by distraint or otherwise, nor debar the Lessor from an action of damages for any loss sustained by any breach of the covenants herein set forth, but that the Lessor may have and use any or all of such remedies as may be deemed proper.   - TENTH.  The Lessee expressly waived to the Lessor any notice to vacate the premises, and, as well, waives the benefit of any Act or Acts of Assembly requiring notice or conferring benefit of any exemption.   - ELEVENTH.  IT IS ALSO COVENANTED AND AGREED between the parties hereto that the successors or assigns1929 BTA LEXIS 2950">*2959  of the said parties shall be bound by and entitled to the benefits of the covenants, conditions and agreements herein contained, in like manner as if they had been respectively named next after the words "Lessor" and "Lessee", respectively, throughout.  14 B.T.A. 1392">*1396  Spang-Chalfant & Co., were manufacturers of pipe and petitioner acquired its entire supply of such materials from that company.  Approximately 83 per cent of the materials used by petitioner were pipe and couplings manufactured by that company.  The leased premises adjoined the plant of that company.  Petitioner secured its supply of pipe on short notice and carried practically no inventory.  Petitioner usually collected from its sales before it became necessary to pay Spang-Chalfant & Co. for the material which went into the goods sold.  The Commissioner determined that the lease had a value of $66,757.68 on March 1, 1913, and allowed a deduction of $3,337.88 from income for the exhaustion of such value.  From 1905 to 1912 certain expenditures of a capital nature were capitalized on taxpayer's books, but, at the insistence of its bankers, were written off against expense prior to 1918.  Such expenditures were not restored1929 BTA LEXIS 2950">*2960  to invested capital in computing the tax liability in question.  Such expenditures include: (1) An item of $430, which was the cost of appraising the plant and buildings of taxpayer in 1916; (2) an item of $4,676.38, which was the amount by which expenses charged to petitioner's "cost of patents" account was written down; (3) an item of $6,284.73, which represented amounts advanced by petitioner to another company or an individual to develop a patent on shoe-tree shiners; (4) an item of "cost of galvanizing process, $5,700.34," which represented the cost of experimental installations for the purpose of developing the processes used by petitioner; (5) an item of "Investment in developing encaustic ceiling process, $10,958.43," representing money spent by petitioner in developing and perfecting a process which, because of war restrictions, petitioner could not manufacture in 1918; (6) an item of "cost of developing food container, Pittsburgh Can Co., $33,395.86," which was the cost of developing a patent to make food cans out of steel sheets instead of tin plate, as had been the custom theretofore; the Commissioner allowed one-third of the amount for invested capital and excluded two-thirds; 1929 BTA LEXIS 2950">*2961  (7) an item of "capital expenditures on account of establishing agencies, $2,008.82," which represents expenditures in securing the approval of the electrical departments of the various cities in which it was desired by the petitioner to do business.  The respondent computed taxpayer's excess-profits tax for the year 1917 under section 210 of the Revenue Act of 1917.  OPINION.  PHILLIPS: The first ground urged by the petitioner is that the respondent computed its profits tax for 1917 under the provisions of section 210 of the Revenue Act of 1917; that the petitioner's situation 14 B.T.A. 1392">*1397  was the same in 1918 as it was in 1917, and that the respondent was therefore in error in refusing to compute its profits tax for 1918 under sections 327 and 328 of the Revenue Act of 1918, which superseded section 210 of the Revenue Act of 1917; that the only ground for computing tax under section 210 of the Revenue Act of 1917 is that the invested capital can not be determined and that if this be so for 1917 it must be equally true for 1918.  It is a matter of official record, disclosed in hearings before congressional committees, that in practice the Commissioner did not limit the application1929 BTA LEXIS 2950">*2962  of section 210 of the Revenue Act of 1917 to the single situation there set out, but broadened the application to cover such situations as are described in section 327 of the Revenue Act of 1918.  In such circumstances it does not follow that section 210 was applied to 1917 by the Commissioner because he was unable to determine the invested capital of the petitioner.  It may have been applied for any one of a number of reasons.  Such application may have been proper or erroneous.  Granting relief in 1917 can not be accepted as proof that error was committed in denying relief in 1918.  The next contention of the counsel for petitioner is that the Commissioner is unable to determine petitioner's invested capital because there were in prior years a large number of expenditures for capital items which had been written off the books and never restored.  The amounts so expended are set out in our findings of fact and we see no insuperable difficulty to the establishment of the facts which would be necessary to permit a determination of the part which each of such expenditures should play in the computation of the invested capital for the taxable year.  The petitioner does not establish1929 BTA LEXIS 2950">*2963  the impossibility of determining invested capital by showing that certain items have been excluded, even assuming that such items should have been included in the computation.  The petitioner's relief in such circumstances is to establish its correct invested capital; not to seek the application of section 328 on the ground that its invested capital can not be determined.  Petitioner further claims that there were abnormal conditions which affected its capital and income.  To establish this it relies upon its inability to include in invested capital any amount for a lease from Spang-Chalfant & Co., and any amount for good will, and also upon its business and credit relations with Spang-Chalfant & Co.  Insofar as the lease is concerned, it appears that the Commissioner determined a March 1, 1913, value of $66,757.68, for which a deduction for exhaustion was allowed in computing net income.  Without questioning petitioner's claim that the lease was valuable or that it had good will, for neither of which any value was allowed in invested capital, we are nevertheless of the opinion that no sufficient 14 B.T.A. 1392">*1398  showing of abnormality has been made.  Petitioner was using in its business, 1929 BTA LEXIS 2950">*2964  which was that of manufacturing, some $360,000 in other assets, which it has been allowed to include in the computation of its invested capital.  Neither the leasehold nor its good will was acquired by the expenditure of any money and neither represented anything which had been risked in the business by petitioner or its stockholders.  Where the item excluded has been the principal income-producing factor and primarily responsible for the production of the income of the taxpayer, we have not hesitated to say that an abnormal situation existed.  . But it does not follow that every time an asset is excluded from invested capital there results an abnormality within the meaning of section 327 of the Act.  . In many businesses there will be some good will, or some appreciation in the value of the assets, or some other factor which can not enter into the computation of invested capital.  The exclusion must be such as to cause exceptional hardship.  The proximity of the petitioner's plant to that of Spang-Chalfant & Co. enabled it to secure its raw material upon very short notice, wherefore1929 BTA LEXIS 2950">*2965  it was unnecessary for petitioner to carry any substantial inventory.  It also purchased its supplies from Spang-Chalfant & Co. upon credit terms which enabled it to ship its finished product to its customers and receive the purchase price from them before it became liable to pay Spang-Chalfant & Co.  The petitioner'w witnesses estimate that if the petitioner had been situated farther from a source of supply of its raw materials and had been required to pay for its goods upon the usual credit terms, it would have required from $300,000 to $350,000 more capital.  These favorable conditions may indicate good management and may have resulted in substantially larger income than could have been hoped for under less favorable conditions, but in our opinion they do not create abnormalities in either the capital or income.  Section 327 of the Act expressly provides that it shall not apply to any case in which the tax is high merely because the corporation earns a high rate of profit upon a normal invested capital.  The record leads us to believe that this was the situation of the petitioner.  No two businesses can be alike in all their factors. 1929 BTA LEXIS 2950">*2966  Each is bound to have certain favorable or unfavorable conditions as compared with others.  It was not to such things as these that Congress had reference in the use of the word abnormalities in section 327, but rather to those situations where by reason of some peculiarity in the corporate structure, invested capital was unusually small as compared with the total capital employed in the business or income was affected by some unusual circumstance.  14 B.T.A. 1392">*1399 . Here none of such circumstances existed.  Petitioner further alleges that its situation is abnormal because it is a member of an affiliated group and the corporations associated with it have operating deficits which have been offset against earned surplus.  Section 240, Revenue Act of 1918.  Without considering whether or not this could ever constitute an abnormality, since it is the income and invested capital of the consolidation which is to be considered, it is sufficient in this case to point out that while petitioner's invested capital was reduced by the operating deficit of its subsidiaries it, nevertheless, had the benefit of the remainder of their invested capital1929 BTA LEXIS 2950">*2967  and at the same time was allowed to reduce its own profit by the amount of the loss of the affiliated corporations.  It is by no means clear that the petitioner suffered by reason of the affiliation; it would perhaps be more justifiable to conclude that its tax would have been greater had there been no affiliation.  Decision will be entered for the respondent.