Court Opinion

ID: 4616795
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:35:13.22002+00
Date Added: 2024-06-11T08:25:53.519394
License: Public Domain

WARREN COUNTY FERTILIZER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Warren County Fertilizer Co. v. CommissionerDocket No. 15999.United States Board of Tax Appeals17 B.T.A. 113; 1929 BTA LEXIS 2354; August 16, 1929, Promulgated *2354  1.  The method of computing profits tax provided by section 302, Revenue Act of 1918, is only used if thereby the tax is lower than it would be under the more ordinary method of section 301; and when section 302 applies, invested capital is not a factor of the computation.  2.  Where a petitioner's statutory invested capital includes a large surplus which petitioner permits to lie idle and petitioner at the same time borrows substantial amounts from its principal stockholder, it would be an artificial construction of section 327 to say that such borrowing constitutes an abnormal condition justifying special assessment.  3.  There is no rule that the failure to pay salaries to some of those who nominally hold office in a corporation or who as stockholders perform a modicum of service in its behalf incidental to outside occupations is an abnormal condition under section 327.  It is a question of fact in each case under all the circumstances.  4.  The unsupported opinion of a witness as to the measure of salaries is not sufficient evidence that the salaries paid constitute an abnormal condition under section 327.  Henry Ravenel, Esq., Henry H. Elliott, Esq., and Victor*2355  Markwalter, C.P.A., for the petitioner.  James A. O'Callaghan, Esq., and P. A. Bayer, Esq., for the respondent.  STERNHAGEN *113  Deficiencies in income and profits taxes of $2,960.64 for the fiscal year ending July 31, 1919, and $1,615.02 for the fiscal year ending July 31, 1920.  These were arrived at under section 302.  Petitioner claims that, because of abnormal conditions affecting capital or *114  income, it falls within section 327(d), Revenue Act of 1918.  The hearing was limited under Rule 62.  FINDINGS OF FACT.  Petitioner herein, a corporation organized and existing under the laws of the State of Georgia since 1911 and during the taxable years in question, was engaged in the manufacture and distribution of fertilizer in Warren County, Georgia.  Its operations consist of mixing, drying and grinding the necessary ingredients of its product, such as acid phosphate, cottonseed meal, etc., all of which it purchases, and selling the finished fertilizer to small cotton farmers within a radius of eight miles of its plant, which is the only one in the small town of Warrenton, although there are others within 150 miles.  The plant, a wooden*2356  building of one story containing simple machinery, is open and operated only about twelve weeks in the year, beginning in March or April.  During this period some fourteen negroes under the direction of a white superintendent unload the materials, get the equipment in working condition, prepare the fertilizer, and pack it in jute bags for delivery.  The bulk of the sales is made during this season, and the plant is closed thereafter except for occasional business.  The ensuing months are devoted to the collection of outstanding accounts and the procuring of raw materials for the coming year, some of which are not ready until March or April of the following spring.  Petitioner has no regular office, its books being kept by its general manager at his cotton gin adjacent to the plant.  During the fiscal years ended July 31, 1919, and 1920, petitioner's capital stock, consisting of 250 shares of the par value of $25,000, was owned by the following shareholders in the proportions named: 19191920C. W. Gheesling10Southern Cotton Oil Co122H. A. Purtell36H. C. Brown1Eugene English1T. T. Miller1A. E. Kitchens5S. E. DuPuis1T. A. English5Besse Cason Battle36Denam Cason5C. R. Fitzpatrick30H. C. Brown1A. Baker5E. R. English10R. S. Mathews5B. T. Johnson1Gene English3T. T. Miller1Denam Cason5W. E. English10E. R. English10C. R. Fitzpatrick35C. W. Gheesling10R. S. Mathews5B. T. Johnson1S. E. DuPuis1T. A. English5Southern Cotton Oil Co122W. E. English10*2357 *115  Permanent investments in buildings and machinery amounted to $1,700 and $1,400 for the respective years.  During the fiscal year 1919 petitioner was indebted to the Southern Cotton Oil Co. and the Virginia-Carolina Chemical Co. combined in the following amounts: July, 1918$43,516.28August, 191848,475.60September, 191850,416.89October, 191845,749.19November, 191837,433.42December, 191837,477.41January, 191943,118.59February, 1919$61,113.65March, 191951,568.56April, 191934,571.71May, 191944,686.08June, 191949,474.00July, 191947,540.67From August to October, $5,000 additional was borrowed from other sources.  During the fiscal year 1920 it owed the following sums: July 31, 1919$47,540.42August, 191953,496.17September, 191953,523.69October, 191916,328.13November, 191913,225.49December, 191913,200.00January, 192016,770.75February, 1920$18,375.00March, 192027,306.70April, 192043,016.28May, 192049,336.81June, 192062,326.06July, 192077,356.46All of the 1920 loans, which were interest-bearing, were borrowed from the Southern Cotton Oil Co. *2358  , except a loan of $12,500 from the Citizens' Bank and one of $2,500 from an individual.  Petitioner's relations with the Southern Cotton Oil Co., its largest stockholder, were very close.  About 50 per cent of its purchases were made through said company at a preferential rate below the market price.  A running account was kept between the two, on which debits and credits were made every few days, and in which it is impossible to segregate the amounts advanced to petitioner as loans from obligations contracted by it for purchases.  In this section of Georgia cotton is planted in April, maturing before the end of July, and is harvested between the latter part of September and early November, depending upon its condition and the labor supply.  During the fiscal year 1919 crops were good in price and volume; in 1920 sales of fertilizer amounted to $220,051.37 gross.  Of this total, $32,349.46 was carried on open accounts and $103,228.46 was covered by notes maturing between October 1 and November 15.  These notes were endorsed to the Southern Cotton Oil Co. as collateral for loans made by it to petitioner for the purchase of materials; petitioner, however, undertook to make collection. *2359  As a general rule the notes were accepted by petitioner without security, and the maker was usually without property against which collection could *116  be enforced.  Croppers were wholly without means of financing themselves, being unable to procure loans from the banks for farming purposes until about March 1, and then only by lien on the growing crop.  About 30 per cent of petitioner's purchasers owned their land, the remainder being croppers without interest in the soil.  As of July 31, 1920, petitioner set up a reserve for bad debts of $6,200, anticipating the inability of farmers to meet their obligations on account of the general condition of cotton and the heavy decline in commodity prices.  On the advice of petitioner's accountant, the reserve was not charged off.  During the fiscal years in question, and since 1915, S. E. DuPuis was petitioner's general manager, in charge of the office, purchases, sales, credits, insurance, and books.  He received a salary of $75 a month.  In addition to managing petitioner's business he had a four or five acre farm and a cotton gin which he operated twelve weeks in the year.  The president, C. R. Fitzpatrick, received no salary. *2360  He was a director, consulted frequently with the manager on questions of policy, and was of assistance in procuring loans by virtue of his position as president of the only local bank and his standing as a planter of means.  The vice president, D. R. English, a director, was a member of the finance committee.  The treasurer, T. T. Miller, who handled the cash and signed the notes, was closely connected with the Southern Cotton Oil. Co.  The secretary, T. F. Bargeron, was filed representative of the Southern Cotton Oil Co. and traveled considerably over the adjacent cotton districts.  He kept currently informed on conditions affecting the industry, and made monthly recommendations to the manager regarding the purchase of materials.  He was a chemical engineer, and advised concerning the mixing and manipulation of fertilizer required for varying soils, giving demonstrations of its use.  OPINION.  STERNHAGEN: Petitioner, a business corporation, subject for 1919 and 1920 to income and profits taxes imposed by the Revenue Act of 1918, contends that the respondent's determination of deficiencies for those two years is erroneous in so far as it results in taxes higher than those which*2361  would be arrived at by the special comparative method prescribed by section 328.  This section applies to the corporate taxpayers described in section 327, and petitioner has sought to bring itself within the class described in subsection (d), which is as follows: (d) Where upon application by the corporation the Commissioner finds and so declares of record that the tax if determined without benefit of this section would, owing to abnormal conditions affecting the capital or income of the *117  corporation, work upon the corporation an exceptional hardship evidenced by gross disproportion between the tax computed without benefit of this section and the tax computed by reference to the representative corporations specified in section 328.  This subdivision shall not apply to any case (1) in which the tax (computed without benefit of this section) is high merely because the corporation earned within the taxable year a high rate of profit upon a normal invested capital, nor (2) in which 50 per centum or more of the gross income of the corporation for the taxable year (computed under section 233 of Title II) consists of gains, profits, commissions, or other income, derived on a*2362  cost-plus basis from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.  The sole question now to be decided is whether the evidence establishes the abnormal condition required by this section.  If so, the parties will proceed further under Rule 62 to arrive at the correct comparative tax; and if not, the respondent must be sustained.  At the beginning of the trial petitioner put in evidence the report of the revenue agent who examined its books and the respondent's statement based thereon, in order to show the method of arriving at the determination here in issue.  Although these exhibits were not offered as proof of the facts which they purported to state and which served as the hypothesis of respondent's determination, it was apparently assumed by both parties that some of the facts would be accepted as found in the report.  Such facts have, however, been omitted from the findings because of the limitation of the offer.  The exhibits show the following for the fiscal years 1917 to 1921, inclusive: YearNet incomeInvested capitalDeficiencyOverassessment1917$11,889.41$42,694.54$2,273.39191818,351.3242,703.87$239.44191929,647.3451,833.142,960.24192036,092.3768,896.971,615.0219211 20, 751.14Since for the years in issue, 1919 and 1920, the profits tax which would result from the use of the method required by section 301, i.e., in accordance with the ratio of income to statutory invested capital, was higher than the percentage method of section 302, the latter was used to limit the tax.  The method of section 302 is only used if thereby the tax is lower than it would be under the more ordinary method of section 301; and when section 302 applies, invested capital is not a factor of the computation.  Petitioner insists that the lower tax under section 302 is still too high and that conditions of income and capital during 1919 and 1920 were abnormal within section 327(d), which the Commissioner has denied.  *118  The evidence shows that, from the time of its incorporation in 1911, petitioner has consistently carried on its operations under the same conditions.  It had very little equipment, which was all it needed.  The Cotton Oil Co. was its largest stockholder and apparently afforded a means of financing which was of mutual advantage.  Whether it can be said, as petitioner contends, that because of this it conducted its business largely on borrowed*2364  capital, may be doubted.  The exhibits show that in respondent's computation of petitioner's invested capital large surpluses were included, and if petitioner permitted these to lie idle while actually using amounts borrowed on running account from the Cotton Oil Co., it would be an artificial construction of the special relief of section 327 to say that such borrowing constitutes an abnormal condition which fairly justifies special assessment.  But whether that be the situation or not - which can not be safely said from the evidence, the invested capital has not by any evidence in this record been shown to be abnormal either in amount or character.  As to income, the condition relied upon as abnormal is that the officers, except DuPuis, took no salaries.  The business required little or no services except those of DuPuis as manager.  Its active season lasted but twelve weeks and during that time Fitzpatrick, who was a substantial stockholder and president of the local bank, devoted a few minutes a day to its problems.  These services and the incidental services of Bargeron, who was an employee of the Cotton Oil Co. and also a small stockholder, were apparently not sufficiently important*2365  to require salary compensation, and in our opinion there was no abnormal condition of income in the failure to pay such salaries.  Furthermore, there is in the evidence no sufficient reason to support the opinion of the witness DuPuis as to the measure of such compensation.  He testified to no other similar services or salaries to be used as a yardstick.  Going a step further, it may well be doubted whether the balance between normal and abnormal income would be seriously affected by the comparatively small aggregate of additional salaries which in his opinion might reasonably have been paid.  The income was $29,647.34 and $36,092.37, and DuPuis' opinion of the value of the services was $3,500 and $4,600 respectively.  See . There is no rule that the failure to pay salaries to some of those who nominally hold office in a corporation or who as stockholders perform a modicum of service in its behalf constitutes an abnormal condition.  See . Whether small or inadequate compensation creates an abnormality is a substantial question in each case and depends upon all the circumstances. *2366  Unless a norm is reasonably established there is *119  no test by which to determine the abnormal.  For all that appears in this record, the situation of this corporation in 1919 and 1920 was consistent with its own history and consistent with that of normal conduct in this industry and in this locality.  To say that under these circumstances it should be taxed upon a standard lower than that conventionally applicable to the ordinary taxpayer would be to create an abnormality in its favor rather than to remedy an unfairness, as the special assessment contemplates.  Reviewed by the Board.  Judgment will be entered for the respondent.SMITH dissents.  Footnotes1. Loss. ↩