Court Opinion

ID: 4631335
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:09:25.091475+00
Date Added: 2024-06-11T07:57:42.189645
License: Public Domain

The Permold Company, Petitioner, v. Commissioner of Internal Revenue, RespondentPermold Co. v. CommissionerDocket No. 25868United States Tax Court21 T.C. 759; 1954 U.S. Tax Ct. LEXIS 291; February 25, 1954, Promulgated *291 Decision will be entered for the respondent.  Petitioner's claims for relief from excess profits taxes for the years here involved under the provisions of subsections 722 (b) (2) and (4) of the Code denied.  M. E. Newcomer, Esq., and H. V. E. Mitchell, Esq., for the petitioner.Clarence Price, Esq., and Stanley W. Ozark, Esq., for the respondent.  Van Fossan, Judge.  VAN FOSSAN *759  Petitioner brings this proceeding in accordance with section 732, Internal Revenue Code, for review of respondent's disallowance of petitioner's claims for relief from excess profits taxes under section 722 of the Code.  Petitioner alleges that it *292  is entitled to refunds of such taxes for the years and in amounts as follows:Taxable yearended Dec. 31Amount1940$ 9,033.18194140,283.11194232,226.49or in such greater amounts as this Court may determine.Petitioner also seeks relief under section 722, supra, for the taxable year ended December 31, 1943, in order to establish an unused excess profits credit carry-back to the years 1941 and 1942.FINDINGS OF FACT.The parties have filed both an original and a supplemental stipulation of facts with exhibits attached.  All of the facts thus stipulated *760  are so found and, by this reference, made a part hereof.  Other facts were established by testimony.Petitioner, The Permold Company, is an Ohio corporation, with its principal office in Medina, Ohio.  During the years here involved, petitioner kept its books on an accrual basis. Its annual accounting period was the calendar year.  Its income and excess profits tax returns were filed with the collector of internal revenue for the eighteenth district of Ohio at Cleveland.Petitioner was incorporated under the laws of the State of Ohio on April 8, 1921.  Shortly thereafter, it commenced business operations*293  by obtaining personnel, acquiring equipment and plant space, and conducting research and investigation, primarily with respect to the manufacture and production of aluminum and aluminum alloy castings by the permanent mold process.  Petitioner did not take over or succeed to the business of any predecessor corporation.In 1921 when the petitioner began its operations, the permanent mold for the production of aluminum castings other than pistons was new and in the experimental stage.  The permanent mold differs considerably from two alternative processes used for the production of aluminum castings, namely, the sand casting process and the die casting process.The sand mold process of fabricating aluminum castings requires an individual mold for each casting and renders the control of crystalline structure and dimensional tolerances difficult.  The die process of fabricating aluminum castings requires the use of steel dies, usually two-part, into which molten aluminum is forced under pressure.  Close dimensional tolerances are obtainable by this process at some risk of internal shrinkage of the casting. The permanent mold process of fabricating aluminum castings requires use of accurately*294  constructed semi-steel cast iron molds, consisting of two or more parts, the cavities of which are coated with refractory substances before molten aluminum is poured into them.  This latter process was introduced into this country and originally developed by Aluminum Company of America (hereinafter referred to as Alcoa) beginning about 1914 and utilized by it during World War I for the casting of pistons for the Liberty Motor.  Although the nature of the permanent mold process resembles that of the die process, the castings produced thereby more nearly resemble those produced by the sand mold process.Following the successful use of the permanent mold process for the production of aircraft engine pistons during World War I, Alcoa and others began to produce automobile engine pistons by the same process.  Petitioner did not initially engage in the production of pistons *761  for fear of becoming embroiled in patent litigation.  At the outset, petitioner embarked on the manufacture of miscellaneous permanent mold castings. In 1925, petitioner entered the field of manufacturing aluminum cooking utensils by the permanent mold process.  It produced in substantial quantities 5-inch, *295  7-inch, and 9-inch frying pans, and 2-, 3-, and 4-quart kettles, a 6-quart preserving kettle, and a hinged frying pan for making omelets.  These products ranged in weight from 6 ounces in the case of the 5-inch frying pan to 5 1/4 pounds in the case of the 6-quart preserving kettle.  Petitioner was also producing vacuum cleaner motor housings.During the years 1926-1928, petitioner lost substantially all of its vacuum cleaner housing business and its cooking utensil business to larger and better established competitors. During this period and thereafter, petitioner undertook to fabricate aluminum castings of washing machine agitators. These early molds as well as the agitators cast therein were unsatisfactory for volume production.  As a result of experimentation with various molds incorporating different design principles, petitioner was able by the early or middle 1930's to develop and perfect a permanent mold capable of turning out washing machine agitators in commercial quantities.Petitioner was granted United States Patent No. 1,770,368 on July 8, 1930, which patent covered petitioner's claims for the design of a permanent mold for the casting of aluminum alloy washing machine*296  agitators. A corresponding Canadian patent covering the same invention was issued to petitioner on December 23, 1930.Petitioner instituted a patent infringement action against Monarch Aluminum Company for alleged infringement of such patent and was granted a decree against the defendant on January 16, 1932.  Petitioner also filed a similar action against National Bronze Company for alleged infringement by it of the patent and was granted a decree against such company on March 8, 1932.  The latter decision was later reversed by the Court of Appeals, on the ground that the National Bronze Company in its operations had not infringed petitioner's patent.In 1932 petitioner designed a mold for a spiral type of agitator for the Easy Washing Machine Company.  Many refinements were found to be necessary.  In 1936 or 1937, petitioner was able to produce a mold capable of efficient commercial production of the Easy "Spiralator."In 1929, petitioner had 7 customers for washing machine agitators. Its gross sales to these customers in that year totaled $ 173,989.70.  By 1930, petitioner had approximately 10 customers to whom it sold such agitators in an aggregate gross amount of $ 338,938.72. *297  Beginning *762  in 1931, competition for the aluminum washing machine agitator casting business increased in severity as a consequence of the economic depression then prevalent.  Petitioner's sales of such agitators declined due to the unwillingness of its officers to produce and offer lower quality washing machine agitators in order to meet competitively quoted prices.  In 1931, petitioner lost entirely 1 customer whose purchases of agitators in 1930 had amounted to a total of $ 6,901.67; it acquired a new customer to whom its sales of washing machine agitators in 1931 aggregated $ 7,421.05; and it did a gross business in such agitators for the year amounting to $ 155,872.65.  Ultimately, unit prices of agitators were lowered by petitioner's competitors to the point where petitioner concluded that it would be useless to try to obtain the business at such prices.  In some instances, unit prices quoted by competitors were below petitioner's cost of production for a similar item.  In 1932, petitioner's total sales of aluminum agitators dropped to $ 103,167.09; it lost the business of 2 customers entirely; and it temporarily lost the business of another.  The latter customer was*298  reacquired 2 years later in 1934 and thereafter was retained through the base period years.  In 1933, petitioner sold an aggregate amount of $ 112,658.83 of agitators to approximately 7 customers. No old customers were lost in that year and no new ones acquired.  Petitioner lost the patronage of 1 customer in 1934.  Its sales to the 7 customers which it retained totaled $ 145,664.02.  In 1935, petitioner temporarily lost 1 account.  To the 6 which it retained, it sold $ 199,341.29 of agitators. The account lost was reacquired in 1938.  Petitioner's total dollar sales of agitators during the base period years follow:1936$ 170,415.691937245,350.371938142,516.151939200,403.58During the above years, petitioner acquired 3 new accounts, reacquired 1 previously lost in 1935, lost 1 account entirely, and lost 1 temporarily in 1937 and 1938, which account was subsequently reacquired in 1939.The following schedule shows the number of electric washing machines produced in the United States during the years 1929-39, inclusive, the total amount of petitioner's dollar sales of agitators for washing machines for each of the years 1929-39, inclusive, and the approximate number*299  of washing machine agitators produced by petitioner in each of such years, respectively, together with the ratio which the number of washing machine agitators produced and sold by petitioner in each year bears to the total number of electric washing machines produced in the United States during such year: *763 Ratio ofUnited Statespetitioner's agitatorPetitioner'sPetitioner'sfactory salessales (units) toYeardollar salesunit salesof washingtotal Unitedof agitatorsof agitatorsmachinesStates washingmachine salesPer cent1929$ 173,989.70105,448955,00011.0  1930338,872.65225,959800,00028.2  1931155,872.65141,702810,00017.5  1932103,167.09130,162565,00017.7  1933112,658.83110,667968,00011.4  1934145,664.02106,0921,120,0009.5  1935199,341.29138,9181,228,00011.3  1936170,415.69119,6741,525,0007.8  1937245,350.37138,6161,465,0009.5  1938142,516.1596,8841,030,0009.4  1939200,403.58174,4161,325,00013.2  Petitioner's sales of washing machine agitators for each of the months September, October, November, and*300  December 1939, were as follows:SeptemberOctoberNovemberDecemberTotal sales$ 22,613.35$ 24,470.03$ 21,402.90$ 9,583.65Average price per agitatorrealized by Permold$ 1.149$ 1.149$ 1.149$ 1.149Approximate number ofagitators sold by Permold19,68121,29718,6278,341Washers sold by industry130,649134,38995,52971,226Ratio of Permold agitator1 15.061 15.851 19.501 11.71sales to industry washer salesAside from washing machine agitators, motor housings, and cooking utensils, petitioner in the early 1930's was producing in commercial quantities aluminum castings of percolator bases, typewriter parts, and electrical contact points.  During these years, it was also actively on the lookout for, and constantly trying to develop, new types of permanent mold business.  Some time prior to 1934, petitioner entered the piston casting field and by that year was doing a substantial business therein.In 1933, automobile manufacturers began to use aluminum cylinder heads for some automobile engines. These heads were originally made by a modified semi-mold process which was developd by Bohn Aluminum and Brass Corporation*301  and called Permanent Mold. By 1934, approximately 75 per cent of all automotive cylinder heads were being fabricated by the permanent mold process by Advance Aluminum Castings of Chicago, which had patented its process, and by Alcoa.  Petitioner watched the progress of the use of the aluminum cylinder head from 1933 on but refrained from entering into the manufacture thereof until well into 1935.  The primary reason for this delay was that petitioner's financial condition was such that it could not afford to expend large sums to conduct the necessary research and experimentation.  Nor did petitioner have a staff of automotive engineers such as its larger and better established competitors had.  Petitioner's *764  officers also thought that profitable knowledge might be obtained by watching the experiences of its competitors.One of petitioner's employees called upon the motor car companies to ascertain what could be done about obtaining cylinder head business for petitioner.  This scouting and preliminary sales activity took place in the early to middle 1935.  Petitioner discovered that the Lycoming Engine Company (hereinafter called Lycoming) was designing a V-8 type engine *302  for the Cord motor car.  Petitioner determined that the Lycoming business would afford a good opportunity to get a start in the production of cylinder heads by the permanent mold process.  Petitioner obtained an order for a mold and an order for heads, both at prevailing prices; at its inception, the Lycoming business appeared to be a good venture.  Petitioner manufactured a mold, poured samples in late 1935, and finally made shipments of the cylinder heads in 1936-37.  While the castings made were in the main, satisfactory, the accompanying scrap losses were very great and the contract was fulfilled by petitioner at a financial loss.Despite its experience in the Lycoming transaction, petitioner continued its effort to break into the cylinder head field.  Chrysler Motor Car Corporation (hereinafter called Chrysler) was at that time using aluminum cylinder heads as optional equipment on the Chrysler Six and Eight.  It abandoned the use of such heads for the Dodge and Plymouth cars about 1936-37.  Petitioner concentrated on a major effort to obtain business from Chrysler.  Its efforts were successful when, in 1936, it obtained orders from Chrysler to design a mold and produce castings*303  of a cylinder head designed by Chrysler engineers for the Chrysler Eight.  Samples of such castings were delivered to Chrysler at the close of 1936 for the purpose of being checked by Chrysler engineers. Following receipt of word from Chrysler to proceed, petitioner began production of such heads in February 1937.  It continued to furnish them to Chrysler throughout the remainder of the base period. In July or August 1938, petitioner received orders from Chrysler for aluminum castings of cylinder heads for the 6-cylinder Chrysler Windsor engine. Petitioner furnished such heads throughout the remainder of the base period. The aluminum cylinder heads made by petitioner for both the Chrysler Six and Eight cylinder engines were offered to the public by Chrysler solely as optional equipment.  The method used by petitioner to produce such heads was a semi-permanent mold process.  The mold involved was of an entirely new type.  Petitioner applied for a patent on this process on December 27, 1938, which patent was granted on March 3, 1941.The aluminum cylinder heads which had been produced by petitioner's competitors during the years 1933-37 did not stand up well under field conditions. *304  These heads cracked, froze, and corroded readily, and freezing on the stud bosses was encountered.  Whereas *765  cast iron and aluminum had been equally priced in the early 1930's, cast iron was now cheaper.  Petitioner never made any sales of heads for the Plymouth and Dodge engines and Chrysler did not commit itself to the use on the Dodge and Plymouth engines of aluminum cylinder heads to be produced by petitioner.  The Ford Motor Company (hereinafter called Ford) abandoned the use of such heads for the Ford car in 1937.  Ford continued using them for the Mercury motor car.  Packard, General Motors, and Studebaker also rejected the use of aluminum cylinder heads prior to the end of the base period.Shortly after it began selling aluminum cylinder heads to Chrysler in 1936-37, petitioner embarked upon a research and experimental program in conjunction with the Automotive Division of the University of Michigan and the automotive industry to determine whether the automotive industry was, or had been, obtaining the optimum results to be derived from the use of aluminum heads.  To head the program for it, petitioner employed an automotive engineer who had previously been an assistant*305  chief engineer at Lycoming.  In order to determine whether the automotive engine companies could utilize the aluminum cylinder head to the best effectiveness from the standpoint of the functioning engine, i. e., maximum horsepower and maximum fuel economy, numerous tests were made.  Petitioner's engineer worked on experiments with the LaSalle engine in cooperation with the chief engineer for engines of General Motors and with the Chrysler engine with the engine man at Chrysler.  Tests were also made on Ford engines wherein petitioner worked with a representative of that company.The following schedule shows the dollar sales of petitioner of aluminum and aluminum alloy automobile cylinder heads made by the permanent mold process during each of the years 1936 to 1941, inclusive, and the approximate number of such cylinder heads produced and sold by petitioner in each of such years:Cylinder head sales 1YearUnitsDollars19363,149$ 15,147.22193714,67670,593.7119387,91338,063.9019399,90347,634.81194012,60760,639.161941 (5 months)7,74537,245.24*306  Prior to the year 1935, petitioner occupied on a rental basis part of a factory building, such part consisting of 8,100 square feet of floor area.  During the year 1935, petitioner increased its rented occupied *766  floor space to 17,100 square feet.  During the year 1938, petitioner again increased its rented occupied floor space by an additional 10,800 square feet.  At the end of 1939, petitioner was renting and occupying and using in its operations a total of 27,900 square feet of floor space. By reason of these increases in the floor space occupied by petitioner, and the installation of furnaces and other equipment in its plant, petitioner acquired, and at all times during the base period, possessed, the physical ability to produce a number of pounds of castings during each of the base period years materially in excess of the actual number of pounds of castings which it did produce and sell during such years, respectively.In 1931, petitioner received an order from Rock Island Arsenal (United States Government) for 19,500 top ring castings and the same number of cover ring castings for aluminum shell containers. Petitioner designed two permanent molds -- one for the production*307  of each of these castings. The contract proved highly unprofitable to petitioner.  During the early base period years, petitioner attempted to secure further orders for the production of similar aluminum castings for private concerns then furnishing the United States Navy Department with shell containers. Petitioner was unsuccessful in securing any orders until the middle of 1938, when it entered into a subcontract for the furnishing of top ring and cover ring castings for aluminum shell containers to the Norris Stamping & Mfg. Co. (hereinafter called Norris) which castings were almost identical with those made previously by petitioner for the Rock Island Arsenal in 1931.During the years intervening between 1931 and 1938, petitioner had tried unsuccessfully to obtain from Alcoa a license to manufacture top and cover ring castings for use of the Navy Department, for the reason that Alcoa held a patent covering the formula for a special purpose alloy specified by the Navy Department.  In 1938 and 1939, petitioner sought and obtained contracts for the manufacture of these items irrespective of the patent rights of Alcoa.  Eventually petitioner paid Alcoa back royalties for infringement*308  of the patent and was permitted thereafter to manufacture the required castings without a license.Under its contract with Norris, petitioner, in 1939, produced and delivered thereto approximately 202,100 sets of top and cover ring castings. Technological advancement in the art of permanent mold casting had progressed to such an extent by that time that petitioner's scrap loss from the manufacture of these castings was less than 0.003 per cent, as contrasted with the scrap loss of approximately 50 per cent which had been encountered in 1931 in the production of the identical castings for the Rock Island Arsenal.The top and cover ring castings purchased by Norris from petitioner *767  pursuant to the subcontract between that company and petitioner were used by Norris as and when delivered to it in 1939, in the assembly of shell containers for delivery to the Government in pursuance of the prime contract between Norris and the Government dated May 16, 1938.In April 1938, petitioner also received orders from Pollak Manufacturing Company (hereinafter referred to as Pollak) for top and cover ring castings for shell containers similar to, but larger than, those made by petitioner*309  for the Rock Island Arsenal in 1931.  New molds were designed by petitioner to produce these castings and the fulfillment of these orders in 1939 resulted in a profit for petitioner.The sales 1 made by petitioner in 1939 of top and cover ring castings to Norris amounted to approximately $ 194,000 and those of similar and larger top and cover ring castings to Pollack total approximately $ 88,000.The following schedule sets forth the net profit or loss from operation, other income or deductions, and the net income or loss, of petitioner for each calendar year 1922 to 1939, inclusive; the average annual loss sustained by petitioner during the period 1922 to 1939, inclusive; and the average annual net income for the period 1936 to 1939, inclusive:Net profitOther netYear(loss) fromincomeNet incomeoperations(deductions)(loss)1922($ 13,816.12)$ 63.17 ($ 13,752.95)1923(22,170.44)41.16 (22,129.28)19243,564.97 104.92 3,669.89 19257,415.25 189.34 7,604.59 1926(14,489.30)(85.70)(14,575.00)1927(24,942.85)113.08 (24,829.77)1928(33,804.54)(73.83)(33,878.37)1929(7,595.27)243.79 (7,351.48)1930(5,446.74)28.76 (5,417.98)1931(35,120.30)42.98 (35,077.32)1932(17,449.10)3.38 (17,445.72)19331,661.14 (295.32)1,365.82 1934$ 822.37 $ 11.40 $ 833.77 19352,531.99 (13.56)2,518.43 1936(8,506.76)1,036.56 (7,470.20)1937(1,089.29)1,518.41 429.12 1938(13,467.94)1,078.47 (12,389.47)193971,907.11 1,579.63 73,486.74 ($ 109,995.82)$ 5,586.64 ($ 104,409.18) Average net loss 1922-1939$ 5,800.51  Average net income 1936-1939$ 13,514.04 *310  The excess profits tax net income of petitioner, as finally determined after audit by the respondent, and as acquiesced in by petitioner, and the petitioner's excess profits tax liability for each of the years, as finally determined by respondent, without the benefit of section 722, are as follows:Excess profits tax liabilityExcess profits tax netper final determinationincome per finalwithout benefitTaxable yeardeterminationof sec. 7221940$ 74,908.61$ 9,033.181941307,289.46114,562.621942546,027.08382,807.70194333,968.88*768  The excess profits credit actually allowed the petitioner in the foregoing computation of its excess profits tax liability by respondent was computed on the basis of petitioner's actual base period net income under the provisions of section 713 (f), and was as follows:1940$ 36,464.67194145,066.55194245,066.55194345,066.55Petitioner's business or the industry of which it was a member was not depressed in the base period because of temporary economic circumstances unusual in the case of petitioner or of such industry.The character of petitioner's business was not substantially changed prior*311  to or during the base period by reason of the introduction of a new product to which may be solely attributed an increase in petitioner's level of earnings.OPINION.Petitioner, alleging that its excess profits taxes for the calendar years 1940, 1941, and 1942 are excessive and discriminatory, here seeks relief under the provisions of section 722, Internal Revenue Code.  2*312  Like relief is also sought for the year 1943 in order to establish an unused excess profits credit carry-back to the years 1941 and 1942.  As grounds for the relief sought, petitioner specifically invokes subsections (2) and (4) of section 722 (b).  3The ultimate findings of fact appearing above, both denying the conclusions asked by petitioner, are dispositive of this case.The simple fact is that petitioner has failed in its efforts to establish that it is entitled to relief within the meaning of subsections 722 (b) (2) and (b) (4).As to subsection 722 (b) (2), it has established neither the existence of a price war, nor, assuming its existence, the depressing effect thereof on petitioner's business.  Normal competition, however severe, is not a qualifying factor for relief.  We cannot, on the record, conclude that the competition experienced by petitioner was either unusual or temporary.*769  Likewise, as to subsection 722 (b) (4), the proof falls short of establishing a substantial*313  change in the character of petitioner's business and operations.  The addition of a new product or a mere change of shape and useful purpose of articles manufactured does not, without more, qualify under the statute.  The departure from previous operation must be real.  Moreover, it must be proved that the higher level of earnings was directly attributable to the new product.  The operation and character of products of many business concerns are constantly changing.  But to afford a basis for relief the incidence of the change must be unusual and substantial and must be affirmatively reflected in the financial history of the company.  Such a cause and effect are not here proven.Petitioner having failed to demonstrate that it is qualified for relief under subsection 722 (b) (2) or (4), we need not discuss its reconstruction of base period net income under those subsections.  It is sufficient to say that the proof does not establish a fair and just amount representing normal earnings that would result in a greater excess profits credit than that heretofore allowed and computed by respondent under the so-called growth formula.Reviewed by the Special Division.Decision will be entered*314  for the respondent.  Footnotes1. Per cent.↩1. These figures with respect to cylinder head sales are those set forth in the original stipulation as regards the number of units sold each year while those relating to the dollar amounts of such sales are as set forth in the exhibit attached thereto and made a part thereof.  Such figures are slightly inconsistent with those given in the supplemental stipulation.  However, we deem the inconsistency immaterial insofar as affecting the conclusions expressed herein.↩1. The stipulation here reads "gross income", but in view of the exhibits attached thereto and made a part thereof, the phraseology so used is obviously in error and should read "sales."↩2. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.(a) General Rule.  -- In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. * * *↩3. While petitioner's claims for refund filed with the Commissioner and the pleadings herein contained claims based upon other subsections of section 722 (b), such other claims have not been pressed or developed in petitioner's brief.  We, therefore, consider them to have been abandoned.  Green Spring Dairy, Inc., 18 T. C. 217↩.