Court Opinion

ID: 4624626
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:55:32.963821+00
Date Added: 2024-06-11T08:31:56.500539
License: Public Domain

MT. VERNON CAR MANUFACTURING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Mt. Vernon Car Mfg. Co. v. CommissionerDocket No. 14207.United States Board of Tax Appeals13 B.T.A. 810; 1928 BTA LEXIS 3179; October 5, 1928, Promulgated *3179 Held, that certain interest notes should be included in invested capital of petitioner at their face values.  Russell A. McNair, Esq., for the petitioner.  A. S. Lisenby, Esq., for the respondent.  SIEFKIN*810  This is a proceeding for the redetermination of a deficiency in income and excess-profits taxes for the calendar year 1921, and the amount in controversy is $13,869.61.  *811  The errors assigned are as follows: (1) The respondent has understated the amount of depreciation on tracks and switches by $1,748.64; and (2) the respondent has understated the invested capital by reason of the exclusion therefrom of certain interest notes of the Lumber Mineral Co.  At the hearing the respondent was granted permission to amend his answer so as affirmatively to allege that the petitioner's invested capital for 1921 was overstated in the respondent's final determination by the amount of $83,300, representing the par or face value of stock of the Lumber Mineral Co. owned by the petitioner.  FINDINGS OF FACT.  The petitioner is an Illinois corporation with principal office at Mt. Vernon.  It is engaged in the business of foundry and*3180  railroad work and the building of freight cars of all descriptions.  In 1906 and thereafter until a fire occurred in 1916 the Lumber Mineral Co., a Maine corporation, was engaged in the lumber and sawmill business at Arbo, Miss.  On June 16, 1906, the petitioner and the Lumber Mineral Co. entered into an agreement whereby the petitioner agreed to loan or advance to the Lumber Mineral Co., from time to time, such sums of money as might be required to meet and pay maturing notes and obligations of the lumber company and also to provide betterments and improvements in the lumber company's plant.  These advancements and loans were to bear interest at the rate of 6 per cent from the date made.  The Lumber Mineral Co. agreed to use its best endeavors to provide suitable lumber for car-building purposes for the petitioner.  The Lumber Mineral Co. further agreed to issue its bonds secured with its property, at any time thereafter, in sufficient amount to cover and secure all sums due to petitioner, or at any time upon petitioner's request to secure its indebtedness to petitioner by mortgage or second mortgage, or deed of trust on all of its property.  Advances for the purpose of paying*3181  off or taking over the notes and deed of trust given by the Lumber Mineral Co. to W. S. F. Tatum for timber were to carry interest at 7 1/2 per cent.  By the terms of the agreement the petitioner agreed to subscribe for 723 shares of the capital stock of the Lumber Mineral Co. at the par value of $100 per share.  No mortgage was ever requested by the petitioner under the terms of this agreement and none was executed.  In arriving at the deficiency involved in this proceeding, there was not included in petitioner's invested capital the sum of $230,126.80, *812  representing the face amount of notes given to the petitioner by the Lumber Mineral Co. of Arbo, Miss., in payment of interest on certain advances made by the petitioner to the said Lumber Mineral Co. during the years 1905 to 1911, inclusive.  The said notes were dated and were in aggregate amounts as follows: Apr. 30, 1907$5,200.48Apr. 30, 190817,110.69Apr. 30, 190924,361.00Apr. 30, 191031,602.22Apr. 30, 191134,745.85Apr. 30, 1912$37,126.43Apr. 30, 191339,358.19Apr. 30, 191440,621.94Total230,126.80Each of said notes had a value equal to the face amount at the date*3182  received by the petitioner.  The petitioner did not include the $230,126.80 as a part of its invested capital on its original or amended return for the year 1921.  No amount has ever been paid to the petitioner on any of the aforesaid notes by the Lumber Mineral Co. or anyone in its behalf.  The petitioner made certain cash advances to the said Lumber Mineral Co. during the years 1905 to 1911, inclusive, as follows: 1905$10,0001906152,0001907180,000190890,000190982,00019101911$5,000Total519,000All of the aforesaid advances were repaid by the said Lumber Mineral Co. to the petitioner as follows: 1907, by issuance of 723 shares of capital stock of $100 each$72,3001913, by cash21,4001917, by cash203,3001918, by cash125,0001919, by cash97,000519,000The aforesaid notes in the total amount of $230,126.80 represented payments of interest on the aforesaid advances.  On the following dates, petitioner debited the surplus account on its books and credited the notes receivable account with the following sums, representing the interest notes set out above, to wit: Dec. 31, 1908$22,311.17Dec. 31, 190924,361.00Dec. 31, 191031,602.22Dec. 31, 191134,745.85Dec. 31, 191237,126.43Dec. 31, 1913$39,358.19Dec. 31, 191440,621.94Total230,126.80*3183  On May 11, 1916, the Lumber Mineral Co., of Arbo, Miss., suffered a disastrous fire.  *813  The aforesaid amount of $230,126.80 was not claimed in the original or amended returns of the petitioner for the years 1917, 1918, 1919, and 1920, as invested capital, nor was the said item allowed as invested capital by the respondent in computing the petitioner's liability for taxes for those years.  The petitioner first made its claim for invested capital on account of the said item in its protest of September 6, 1923, to the Commissioner's 30-day letter of July 5, 1923, proposing additional income and profits taxes for the calendar year 1918 to 1920, inclusive.  The petitioner did not include the said item of $230,126.80 as an asset on its capital-stock-tax returns, in schedule A thereof, for the years 1917, 198, 1919, 1920, or 1921.  Petitioner executed a general waiver of the benefit of the statute of limitations for all years prior to and including the return for the period ending June 30, 1919.  On July 19, 1923, petitioner filed a claim for refund of $4,275, a portion of additional capital-stock tax paid for the years 1920 to 1923, inclusive, based on the revenue agent's*3184  report, and the Commissioner's letter of July 5, 1923, proposing the assessment of additional income taxes for the years 1918 to 1920, inclusive.  Prior to a determination of this claim for refund, the capital-stock-tax division of the Bureau of Internal Revenue procured, and had knowledge of petitioner's protest of September 6, 1923, and the Income Tax Unit's determination thereon.  A refund of $1,830 was allowed.  In accordance with the stipulation of the parties the petitioner's invested capital for the year 1921 should be increased by either or all of the amounts of $16,094.46, $11,880.17, and $1,528, representing the petitioner's decrease in taxes for the respective years 1918, 1919, and 1920, affecting its invested capital for 1921 in the said amounts.  In arriving at the amount of the deficiency in tax for the year 1921, upon which this petition for redetermination is based, the respondent computed the invested capital as follows: Capital stock$200,000.00Surplus, Dec. 31, 19204,934,054.21Workmen's compensation reserve158,418.165,292,472.37Deduct additional income and profits taxes:1917$20,947.471918161,701.17191996,474.05Proration of 1920 income and profits taxes64,043.84Inadmissible assets60,180.59403,347.124,889,125.25*3185 *814  Said surplus as of December 31, 1920, does not include the sum of $230,126.80.  The stock of the petitioner is held by about 30 stockholders, but the controlling interest has always been held by the family of W. C. Arthurs, who has been president of the petitioner since 1908.  At the end of each year in which interest notes were received by the petitioner from the Lumber Mineral Co., Arthurs directed his bookkeeper to charge such interest notes from the books so as to reflect a conservative balance sheet in order to maintain a good credit rating.  It was known to the petitioner that there would be delay in receiving payment on the interest notes.  The policy of the petitioner was to keep the statement of assets upon the books written down to the amount where that much could be realized from them.  Petitioner wanted nothing on the books that would not readily yield proceeds.  When the interest notes were received by the petitioner they were credited to interest account and charged to notes receivable on petitioner's books.  When they were charged off, the notes account was credited and the surplus account was charged in like amount on petitioner's books.  Afer some of*3186  the notes were charged off, the petitioner continued to make advances to the Lumber Mineral Co.  At or prior to the charging off of the notes the petitioner had never sued the Lumber Mineral Co. for payment thereof.  On or about April 30, 1914, the petitioner waived further interest on the advances made by it to the Lumber Mineral Co. until the company was in better financial condition.  The Lumber Mineral Co. has never disclaimed liability on these notes and they have always appeared on its books as obligations.  On November 28, 1927, the Lumber Mineral Co., by H. H. Cust, president, and Henry T. Jones, secretary, wrote the petitioner a letter which stated in part: Your company and a number of your individual stockholders own large blocks of stock in this corporation and our relations have been very close.  We realize that the statute of limitations has run against these several interest notes and it is possible, that, in any legal action taken to collect on them, the statute might be successfully pleaded.  However, we desire to state that it has never been our idea nor intention to avail ourselves of that or any other possible defense.  We, therefore, beg to assure you that*3187  this company waives the benefit of the statute of limitations on this company's notes held by you, namely, * * *.  No meeting of the board of directors of the Lumber Mineral Co. was held in regard to waiving the statute of limitations.  Up to and including 1921 the petitioner never made demand on the Lumber Mineral Co. for payment of the interest notes.  The Lumber Mineral Co. was actively engaged in the manufacture of lumber and turpentine products, running a general store, *815  commissary and branch stores until a fire destroyed the mill in May, 1916.  In 1911 the company had 14,642 acres of land and from 6,000 to 10,000 acres of timber rights.  In 1914 and 1915 approximately $40,000 had been expended in extending its mill and the capacity had thereby been greatly increased.  After the fire the mill was not rebuilt because the company had no assurance that it could obtain machinery within a reasonable time, and because the price of machinery had advanced from 60 to 100 per cent.  Labor conditions were also bad.  In the early part of 1917, after the insurance had been collected on the property destroyed by fire, the company decided to liquidate the business and proceeded*3188  to collect their accounts and convert their assets into money to pay off cerditors.  Since 1918 the company disposed of such of their property as they were able to and the only business the company has since engaged in has consisted of disposing of its assets, settling its liabilities, and operating two farms of not over 200 acres of cultivated lands.  Of the total of 1,206 shares of stock of the Lumber Mineral Co. outstanding, the petitioner owns 723 shares.  The remainder is owned by 8 or 10 persons.  The capital stock of the Lumber Mineral Co. has a par value of $100 per share.  The petitioner charged off its books on December 31, 1916, the capital stock of the Lumber Mineral Co. owned by it.  No dividend was ever paid on the stock of the Lumber Mineral Co.  There have been no directors' meetings of the company since 1919.  W. C. Arthurs, at present president of the petitioner, has been an officer thereof since 1890.  He was a stockholder and director of the Lumber Mineral Co. from the date of its organization until 1919.  H. H. Cust has been assistant to the president of the petitioner since 1918.  From 1903 to 1918, he was president and treasurer of the Lumber Mineral Co. *3189  He has been a director of such company since 1903 up to the present time.  The present directors of the Lumber Mineral Co. are H. H. Cust, W. C. Arthurs and R. K. Weber, who owns 10 shares of stock in the Lumber Mineral Co.  The balance sheet of the Lumber Mineral Co. as of January 1, 1917, was as follows: ASSETSCash on hand and banks$30,184.56Mt. Olive property149,544.00Outside timber account84,132.00Plant and tool account133,291.51Bills receivable119,11Team investment account2,647.00Turpentine investment2,025.00Construction account$394.17Railroad construction12,389.39Feed account167.90Hot Springs account1,528.56Hubbard Mill machinery100.00Portable sawmill machinery300.00Fire account119,007.20Accounts receivable7,951.58Farm investment account14,213.33Farm trading account1,096.77Farm potato account385.13farm expense2,796.88Camp store check account48.30Insurance and taxes9,241.19Mt. Vernon interest account765.21Supply house account6,880.59Attorney's fees account150.00Oil and waste account26.93Inventory - general expense$1,632.18Inventory - lath and lumber25,021.22Inventory - commissary14,007.11Inventory - turpentine and rosin8,163.3648,823.87Additional assets:Inventory - 5,000,000 ft. standingtimber at $4.00 per M ft20,000.00Inventory - 11,317 acres land at $7Inventory - 3,308 acres land at $1033,080.00181,122.87Total assets760,509.18LIABILITIES AND NET WORTHBills payable Mt. Vernon$695,984.43Bills payable commercial5,500.00Store check account193.45Accounts payable2,508.99Pay roll and labor278.92Farm receipts492.60Depreciation66,000.00Total liabilities770,895.39Net worth:Capital stock$120,600.00Net loss130,986.2110,386.21Total liabilities and net worth760,509.18*3190 *816  All of the above items were taken from the company's books except the items comprising "additional assets." The item "Mt. Olive property, $149,544.00" includes land valued at $3 per acre and also timber.  *817  There were also more than 5,000,000 feet of good merchantable timber which were not carried on the books, but which are included under additional assets in the balance sheet.  The value of this was about $4 or $5 per thousand feet.  The item "11,317 acres of land at $7.00 - $79,219.00," is included under additional assets to represent the difference between the $3 per acre valuation of land carried in the "Mt. Olive" account and the value of the land as calculated by the company.  This 11,317 acres of land was assessed at $6 per acre in 1917.  In the county in which the land is situated land is assessed at about 50 per cent less than its real market value.  The land in question was worth $10 or more per acre.  The item "3,308 acres of land at $10.00 - $33,080.00" represents land held by the company which was not carried on the books.  The timber thereon had been sold to the Kolla Lumber Co. under a 5-year lease.  The value of the land was not carried on*3191  the company's books because the timber had not been cut and the company did not customarily inventory their land until the timber had been removed.  This land was southeast of the main body of the land and was near Collins, Miss.  It was just as near the railroad as the other and was at least as valuable.  It was conservatively worth $10 per acre.  The item "Bills Payable, Mt. Vernon, $695,984.43," includes both principal and interest notes given by the company to the petitioner.  The balance sheet as of January 1, 1918, was as follows: ASSETSCash on hand and banks$21,820.51Mt. Olive property33,951.00Plant and tool account63,210.89Bills receivable157,542.67Team investment498.00Accounts receivable10,440.56Farm investment No. 114,247.53Farm expense No. 13,913.14Farm investment No. 23,825.02Supply house account5,063.61Inventory - general expense$775.00Inventory - commissary807.07Inventory - lumber and lath4,569.67Total6,151.74Additional assets:Inventory - 5,000,000 ft. standing timber at $4per m ft20,000.00Inventory - 11,317 acres land at $779,219.00Inventory - 3,308 acres land at $1033,080.00138,450.74Total assets452,963.67LIABILITIES AND NET WORTHBills payable$456,355.92Store check account133.45Accounts payable1,134.31Pay roll and labor438.12Farm receipts (1917)2,236.45Total liabilities460,298.25Net worth:Capital stock$120,600.00Net loss127,934.587,334.58Total liabilities and net worth452,953.67*3192 *818  The balance sheet as of January 1, 1919, was as follows: ASSETSCash on hand and banks$32,029.59Mt. Olive property33,951.00Plant and tool account16,740.00Bills receivable72,917.67Team investment370.00Accounts receivable3,452.35Farm investment account 115,528.92Farm trading account1,339.02Farm expense account No. 1762.90Farm investment account No. 26,387.92Inventory - general expense$396.50Inventory - lumber on hand224.00Inventory - coal on hand160.00Inventory - commissary and supplies315.98Inventory - hay and feed85.40Total1,181.88Additional assets:Inventory - 5,000 feet standing timber at $4per M ft20,000.00Inventory - 11,317 acres land at $779,219.00Inventory - 3,308 acres land at $1033,080.00134,662.76Total assets316,960.25LIABILITIES AND NET WORTHBills payable$327,126.80Pay and labor165.82Store check account130.75Total liabilities327,423.37Net worth:Capital stock$120,600.00Net loss131,063.1210,463.12Total liabilities and net loss316,960.25*819  The balance sheet as of January 1, 1920, was*3193  as follows: ASSETSCash on hand and banks$17,751.57Mt. Olive property33,951.00Plant and tool account6,570.00Bills receivable200.00Accounts receivable1,747.58Farm investment No. 115,328.92Farm investment No. 25,419.42Farm trading account1,466.15Farm expense No. 1619.50Farm expense No. 23,231.00Inventory - general expense$515.60Inventory - lumber on hand185.21Inventory - commissary and supplies197.43Inventory - coal on hand122.00Total1,021.14Additional assets:6,660,000 feet standing timber at $4M feet26,640.0011,317 acres land at $9.84 per acre111,359.283,308 acres land at $12.84 per acre42,474.72181,495.14Total assets267,780.29LIABILITIES AND NET WORTHBills payable$230,126.80Total liabilities230,126.80Net worth:Capital stock$120,600.00Net loss82,946.5137,653.49Total liabilities and net worth267,780.29The liabilities set forth represent the interest notes held by the petitioner.  The 6,660,000 feet of timber listed under additional assets represented standing timber located near Mize, Miss.  In November or December, *3194  1917, the Wood Lumber Co. offered the Lumber Mineral Co.  $4 per thousand feet for this timber.  Under additional assets is included 11,317 acres of land at $9.84 per acre.  In 1924 the company sold 1,800 acres at an average price of $12.84.  It could have been sold in 1920 for that amount.  The fair market value of this land at January 1, 1920, was $12.84 per acre.  The value of the 3,308 acres of land at January 1, 1920, was also $12.84 per acre.  The balance sheet as of January 1, 1921, was as follows: ASSETSCash on band and banks$21,417.48Mt. Olive property33,951.00Plant and tool account2,125.00Bills receivable285.00Farm investment No. 1$15,164.62Farm investment No. 25,706.53Farm trading account1,213.79Farm expense No. 1210.00Farm expense No. 22,236.00Accounts receivable1,214.76Inventory - lumber on hand$91.35Inventory - commissary and supplies204.95Inventory - office supplies and fixtures435.50Total731.80Additional assets:Inventory - 6,660,000 feet standing timberat $4 per M feet26,640.00Inventory - 3,308 acres land at $12.8442,474.72Inventory - 11,317 acres land at $9.84111,359.28181,205.80Total assets264,729.98LIABILITIES AND NET WORTHBills payable$230,126.80Total liabilities230,126.80Net worth:Capital stock$120,600.00Net loss85,996.8234,603.18Total liabilities and net worth264,729.98*3195 *820  The quantity of standing timber shown under additional assets does not purport to cover all of the second growth of timber but only that which was available to transportation and which could have been sold at that price at the time.  In 1917, the company sold the Kolla Lumber Co. 40,000,000 feet of timber for $6 per thousand feet.  This timber was of the same character as that on the other portions of the Lumber Mineral Co.'s property.  After the sale the company still had about 10,000,000 feet of timber of which 5,000,000 was available for sale.  The profit and loss account on the books of the Lumber Mineral Co. showed the following: Jan. 1, 1913, loss$153,537.49Jan. 1, 1914, loss193,711.52Jan. 1, 1915, loss245,462.45Jan. 1, 1916, loss259,161.33Jan. 1, 1917, loss263,285.21This account showed a deficit at the end of each year from 1917 to 1921.  At the beginning of 1921 it showed a deficit of $266,470.82.  These deficits represented losses from operations and from capital transactions.  They include accrued interest which was charged to operating expense.  In determining the deficiency appealed from in this proceeding for the*3196  calendar year 1921, the respondent included in the petitioner's *821  invested capital an item of $83,300 representing the cost to the petitioner of stock owned by it in the Lumber Mineral Co., or par value thereof.  The par value of this stock was not set up as an asset in the income-tax returns of the petitioner for the years 1917 to 1921.  W. C. Arthurs, who held 200 shares of the Lumber Mineral Co. stock sold it to H. H. Cust in 1919 at $10.  A capital-stock-tax return of the Lumber Mineral Co., which was signed by H. H. Cust, did not include among the assets the additional assets referred to hereinbefore, nor was any value included for capital stock.  A statement was attached thereto stating that the capital stock had no value.  OPINION.  SIEFKIN: The principal issue in this proceeding is the disallowance by the respondent of $230,126.80 as invested capital of the petitioner in 1921.  This sum is the total face value of notes given to the petitioner by the Lumber Mineral Co. in payment of interest on certain advances made by the petitioner to the Lumber Mineral Co. during the years 1905 to 1911, inclusive.  The amounts and dates of the notes were as follows: Apr. 30, 1907$5,200.48Apr. 30, 190817,110.69Apr. 30, 190924,361.00Apr. 30, 191031,602.22Apr. 30, 191134,745.85Apr. 30, 191237,126.43Apr. 30, 191339,358.19Apr. 30, 191440,621.94Total230,126.80*3197 The petitioner, as its principal proof in support of its contention that the face value of the notes should be included in its invested capital in computing its profits tax for 1921, introduced evidence with respect to the financial condition of the maker of the notes from 1918 to 1921.  It also relies upon the decision of this Board in , where we held that the stock of the Lumber Mineral Co. was worth par on March 1, 1913.  Other evidence in support of its case will be discussed later. With respect to the evidence of net worth of the Lumber Mineral Co. from 1918 to 1921, the respondent's contention is that the requirement of section 326(a)(3) of the Revenue Act of 1921 makes such proof immaterial.  That section is as follows: That as the term is used in this title the term "invested capital" for any year means * * *: * * * (3) Paid-in or earned surplus and undivided profits, not including surplus and undivided profits earned during the year.  The respondent points to this language of the statute, as interpreted by the Supreme Court of the United States in *3198 , and similar language in section 207(a)(3) of the Revenue Act of 1917, as construed by the Supreme *822  Court of the United States in , as requiring that the value of the asset sought to be included in invested capital be proved as of the date of its receipt.  In the La Belle Iron Works case, the Supreme Court said: It is clear enough that Congress adopted the basis of "invested capital" measured according to actual contributions made for stock or shares and actual accessions in the way of surplus, valuing them according to actual and bona fide transactions and by valuations obtaining at the time of acquisition. (Italics supplied.) In the light of the above, the proof of net assets of the Lumber Mineral Co. from 1918 to 1921 does not bear upon the question at issue, i.e., the value, if any, of the notes in question when received by the petitioner, that is, during the years 1907 to 1914, inclusive.  The evidence in support of the respondent's further position that the notes had no value at the dates received is the fact that each of*3199  such notes was charged off the books of the petitioner in the year in which received; the fact that the petitioner never made any claim for these notes as invested capital until 1923 (as indicative of the opinion of the petitioner's officers of the value of such notes); the fact that from 1914 further interest was waived because of the financial condition of the Lumber Mineral Co., and the fact that the notes were not listed as an asset upon the capital-stock-tax returns of the petitioner.  The petitioner argues that the notes were charged off because of an ultra-conservative method of accounting employed by it, points to the finding of the Board in the W. C. Arthurs case, supra, as evidence of the financial condition of the Lumber Mineral Co., at least on March 1, 1913, and further calls attention to the advances made to the Lumber Mineral Co. by the petitioner in the years in which the notes were received.  The notes were dated April 30 of each year from 1907 to 1914, inclusive.  In 1907, when the interest note of $5,200.48 was received by the petitioner from the Lumber Mineral Co., the petitioner advanced $180,000 to the Lumber Mineral Co.  In 1908 an interest note of $17,110.69*3200  was received by the petitioner and $90,000 advanced.  In 1909 the interest note was for $24,361, and $82,000 was advanced.  Nothing was advanced in 1910 but an interest note of $31,602.22 was received by the petitioner.  In 1911 the last advance was made, in the amount of $5,000, and an interest note of $34,745.85 was received.  In 1912 the petitioner received an interest note for $37,126.43.  In 1913 it received an interest note for $39,358.19 and as payment of $21,400 on the principal.  In 1914 it received an interest note for $40,021.94 and further interest was waived until the Lumber Mineral Co. was in better financial condition.  An "operating deficit" in each of the years in question is relied upon by the respondent also as showing that the notes were of no value.  This argument loses its weight, however, when it is considered that the *823  so-called "operating deficit" included the interest notes, and that up to the time the mill was burned in 1916 the Lumber Mineral Co. was expanding its business and actively engaged in its operation, which, from all the evidence, seems to have fairly promised to be successful.  We conclude, from all the evidence, that the notes were*3201  worth their face value at the time paid in.  With respect to the affirmative allegation of the respondent, that is, that he was in error in including in the petitioner's invested capital for 1921 the sum of $83,300 on account of the par value of the stock of the Lumber Mineral Co., the evidence is clear that petitioner's investment in that stock was charged off its books on December 31, 1916, and that it had no substantial value after that date.  We conclude that the evidence affirmatively sustains the respondent's allegation and that he was in error in including the par value in the petitioner's invested capital.  No evidence having been introduced with regard to the first assignment of error, the holding of the respondent in that respect is affirmed.  Judgment will be entered under Rule 50.