*2164 Special assessment denied.
*275 The Commissioner determined a deficiency of $541.36 for 1919 and a deficiency of $10,123.34 for 1920 in the petitioner's income and profits taxes. An earlier hearing in this case was limited under Rule 62 of the Board's rules of practice to the issues other than those involving special assessment. The opinion of the Board relating to the first hearing is reported in 15 B.T.A. 183">15 B.T.A. 183. That left for consideration the petitioner's allegation that the Commissioner erred in denying its application to have its profits taxes computed in accordance with section 328 of the Revenue Act of 1918. At the hearing the petitioner was permitted to amend its petitioner to allege an error relating to the value of its good will.
FINDINGS OF FACT.
The petitioner is a New York corporation with its principal offices in New York City. It was incorporated in 1905 to take over a business which had been conducted as a partnership since 1847. Its business consists*2165 of importing, manufacturing, and selling plate and window glass, and a variety of glass articles and specialties.
In the manufacture of mirrors, which is a large part of the petitioner's business, a chemical process is used for silvering the back of the mirror glass. Some difficulty is encountered in the application of this process on account of the tendency of the silvering to crack or peel off. Under the process or processes in use by the petitioner prior to the years in question, the durability of the mirrors manufactured by it varied. The first coat of silvering would sometimes deteriorate before the mirrors were shipped from the petitioner's factory, and sometimes after shipment, being often the result of jarring in transportation. Practically all of the mirrors manufactured by the petitioner and by other manufacturers were defective in this respect, or were subject to become so. A speck of dust or dirt would eventually cause the silvering to come off, although the defect might not be apparent to the consumer until the blemish attained considerable size.
*276 On account of deterioration discovered before the goods left its factory, the petitioner found it necessary*2166 to resilver approximately 3 1/2 per cent of the mirror glass that it manufactured. During the years from 1914 to 1918, both inclusive, 2,664.071 square feet, or an average per year of 532.814 square feet of mirror glass were silvered in the petitioner's factory, of which 91,101 square feet, or an average per year of 18,220 square feet, required resilvering. The necessity of resilvering caused extra expenses for freight and reboxing the products. In addition, the actual cost of the resilvering amounted to about 25 cents per square foot. The petitioner kept no segregated account in its books of the resilvering costs and incidental expenses.
Prior to the years in question, Dreyfuss, who has been president of the petitioner since 1917, discovered a silvering process for use in the manufacture of mirrors which he and other officers of the petitioner believed was a considerable improvement over the one or ones then in use. Dreyfuss had experimented for about five years in developing his process, during which time he kept no account of his expenses. At some time during the year 1919 the petitioner adopted the use of Dreyfuss' process in the manufacture of high grade or "French" mirrors, *2167 which differ from other mirrors in that plate glass rather than ordinary window or sheet glass is used in making them. The process was used only on "French" mirrors because of the demand for high quality in their manufacture. Other mirrors manufactured by the petitioner are of a poorer quality and cheaper. The process was used experimentally by the petitioner in 1919. In 1920 the petitioner adopted the process in the manufacture of all of its "French" mirrors under an agreement with Dreyfuss that b would be compensated in the form of royalties for the use of the process, and that if after further trial it proved satisfactory the petitioner would purchase it. During 1920 Dreyfuss was paid three-fourths of a cent per square foot of mirror glass in the manufacture of which the process was used. This rate of compensation was determined by reference to the petitioner's records and a computation of how much the process might save the petitioner. The satisfactory nature of the process was partially established in 1919 and 1920, and was definitely established by December 26, 1922. On the latter date Dreyfuss sold the process to the petitioner in consideration of the issuance to him*2168 of 1,000 shares of the petitioner's second preferred cumulative stock of the par value of $100 per share. Under the Dreyfuss process the resilvering difficulty was obviated to the extent that only between one-half and three-fourths of one per cent of the mirrors manufactured required resilvering. In 1919 and 1920 the petitioner silvered 883,179 square feet, or an average per *277 year of 441,589 square feet of mirror glass, of which 5,997 square feet, or an average of 2,999 square feet, were resilvered. The mirrors manufactured under the Dreyfuss process were of a more constant and durable quality, and consequently the petitioner was enabled to guarantee them for a longer period than it had previously guaranteed its mirrors. Furthermore, under the Dreyfuss process about twice as much silver was "reclaimed," or left as residue after the silvering process was complete. Under prior processes not more than $2,000 worth of silver was reclaimed by the petitioner annually.
The Dreyfuss process is a secret one. It has never been patented, nor was there during 1919 and 1920 any trade-mark or copyrighted name used on mirrors manufactured under it. It is the policy of the petitioner's*2169 officers not to patent processes or devices used in its factory, as they deem it more advisable to use them secretly as long as possible. Other companies which manufacture mirrors use silvering processes, the nature and quality of which are unknown to the petitioner's officers. The petitioner was able to sell its mirrors which were manufactured under the Dreyfuss process at a higher price than its competitors could sell mirrors of a like kind.
The petitioner's total gross sales in 1919 and 1920 amounted to $1,155,269 and approximately $2,389,000, respectively, and manufacturing costs amounted to $797,145 and $1,430,417, respectively. The gross sales of "French" mirros amounted to $252,452.65 in 1919 and to $810,594.36 in 1920.
Prior to the year 1914 the petitioner imported from Europe many flat glass items of different shapes, such as are used in meters, clocks, watches, electrical instruments, and various other devices. With the war came the necessity of manufacturing these articles in this country, and on account of the high cost of labor here, the petitioner's officers began experimenting with a glass-cutting machine. Such a machine was invented by them at some time prior*2170 to 1917, and several of them were in use in the petitioner's factory in that year and in 1918 and 1919. In 1920 the petitioner was using about 100 of these machines, all of which had been manufactured in its factory at a cost of about $100 apiece. The cost was charged to expense on the petitioner's books.
Under the hand method of manufacture it had been necessary in order to make a glass in the shape of a hexagon, for instance, to have a skilled workman cut the sides thereof separately, and often to put the corners through a grinding process in order to smooth them. Under the machine method a pattern of the desired shape was placed in one of the machines, and the cutting process was completed by a *278 single stroke of a lever. The cutting machine was never patented. Other concerns engaged in the same business as the petitioner used the hand method of cutting glass until within the past two or three years, when machines somewhat similar to the petitioner's have been available to purchasers.
In 1919 the petitioner began to use beveling and polishing machines in its business. These operations had formerly been done by hand. In 1920 there were 36 of these machines*2171 in use in the petitioner's factory which had been built there at a cost of approximately $1,200 each. The cost was not capitalized, but was charged to expense on the petitioner's books. The use of the cutting machines and of the beveling and polishing machines reduced to some extent the petitioner's manufacturing costs per unit and permitted increased production. Skilled labor was no longer necessary as it had formerly been. The petitioner's increased business in 1920, however, made it unnecessary to reduce its operating force despite the labor saved by the use of the machines.
The parties have agreed that $108,095.41 represents the amount of borrowed money in use by the petitioner throughout 1920. Interest was paid on the loans at the annual rate of 6 per cent. The borrowed money was used in the regular conduct of the petitioner's business.
The salaries paid to the petitioner's officers in the year 1920 were as follows:
| Joe Dreyfuss, president | $25,000.00 |
| Francis Gardner, vice president | 25,000.00 |
| J. B. Lauer, vice president | 9,059.96 |
| Max Ellinger, vice president | 8,499.96 |
| A. J. Levy, treasurer | 5,836.00 |
| Isadore Sobel, secretary | 25,000.00 |
During*2172 the year 1920 Dreyfuss managed the petitioner's finances and credits, supervised the executive branch of the business, and made sales; Gardner was the general supply purchaser, and supervisor of sales and salesmen; and Sobel managed the petitioner's factory, and made sales. Lauer, Ellinger, and Levy did executive work. In 1920 Dreyfuss, Gardner, and Sobel made about 40 per cent of the petitioner's gross sales, for which they received no compensation other than their salaries. The usual commission on sales of products manufactured by the petitioner is 5 per cent. All of the officers except Ellinger devoted their full time to the petitioner's business. Dreyfuss, Gardner, and Sobel sometimes worked on Sundays and holidays. They averaged about 14 hours of work a day.
*279 The parties stipulated that the profits and a loss of the petitioner for the following years were in the following amounts:
| Loss | Profit | |
| 1909 | $65,853.06 | |
| 1910 | 110,527.51 | |
| 1911 | 48,043.28 | |
| 1912 | 54,412.98 | |
| 1913 | 152,920.89 | |
| 1914 | 46,617.39 | |
| 1915 | $4,136.30 | |
| 1916 | 204,467.38 |
The parties have stipulated that the net tangible assets were carried on the petitioner's books*2173 at the following amounts on the following dates:
| January 1, 1909 | $181,051.57 |
| January 1, 1910 | 195,139.31 |
| January 1, 1911 | 222,785.35 |
| January 1, 1912 | 279,588.66 |
| January 1, 1913 | 293,123.05 |
| January 1, 1914 | 295,990.65 |
| January 1, 1915 | 302,692.71 |
| January 1, 1916 | 396,500.00 |
The Commissioner determined that the petitioner's net income for 1920 was $515,335.14, and that its invested capital was $476,194.85.
In the statement accompanying the deficiency notice the following appears in explanation of the Commissioner's denial of the petitioner's application for special assessment:
After careful consideration and review of your protest dated August 1, 1925, and of all of the evidence submitted in support of your contentions, also, conference September 22, 1925, you are advised that the Bureau holds that the comparatives used are representative concerns engaged in a like or similar trade or business to that of your company and meet all the requirements of Section 328 of the Revenue Act of 1918 as near as may be. Inasmuch as an exceptional hardship has not been suffered evidenced by gross disproportion between the tax computed without the benefit of Section 328*2174 and the tax computed by reference to the representative corporations specified in that Section, the conclusions set forth in the above-mentioned letter are sustained.
OPINION.
MURDOCK: The petitioner contends that it is entitled to have its excess-profits taxes for the year 1920 determined as provided in section 328 of the Revenue Act of 1918, due to the existence of certain alleged abnormalities which bring it within section 327(d) of the same act. It was alleged in the petition that the error relating to special assessment was committed for both the years 1919 and 1920, but at the hearing and in its brief the petitioner mentions only the *280 year 1920, and no proof was offered in regard to the year 1919. Section 327(d) provides that the tax shall be determined as provided in section 328:
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 condition affecting the capital or income of the corporation, work upon the corporation an exceptional hardship evidenced by gross disproportion between the tax computed without benefit of this section and*2175 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 cost-plus basis from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.
The petitioner first contends that no amount representing the Dreyfuss silvering process, the cutting machines, or the beveling and polishing machines used in 1920 was included in invested capital for that year, and the exclusion results in an abnormality within the meaning of the above quoted provision.
The total cost of all machines used in 1920 represented a capital expenditure, which, after proper deductions for depreciation and obsolescence, would represent an asset of the company in 1920. The secretary of the petitioner*2176 testified as to the approximate cost of the various machines in use in 1920, but there was no proof of the time at which the machines were put in use or of their probable useful life. Due to insufficient proof, we can not make a proper adjustment to invested capital to reflect the depreciated cost of these machines. Instead of proving these facts, the petitioner asks this Board to hold that an abnormality results from the fact that the cost of the machines was not capitalized and they were very valuable. Where it appears, as here, that the taxpayer has neglected to get the benefit of all of the invested capital to which it is entitled, we will not order special assessment. Edwin M. Knowles China Co.,9 B.T.A. 1292">9 B.T.A. 1292; Cramer & King,13 B.T.A. 399">13 B.T.A. 399, affd., 41 Fed.(2d) 24; Union Drawn Steel Co.,15 B.T.A. 761">15 B.T.A. 761. Until we know the amount of invested capital to which a taxpayer is entitled, it is difficult to determine that there is any abnormal condition affecting its capital or income. Cf. *2177 Pine Bluff Compress & Warehouse Co.,5 B.T.A. 938">5 B.T.A. 938; Max Zeigler & Bros.,12 B.T.A. 838">12 B.T.A. 838. There is no evidence to show that other companies were not equipped with similar beveling and polishing machines, and there is no evidence to show that either the cutting or the beveling and polishing machines effected a saving or had a value in excess of the amount at which they should be reflected *281 in invested capital. Without some such showing, we would never get to the question of an abnormality. Cf. Enameled Metals Co.,14 B.T.A. 1392">14 B.T.A. 1392; Cohn Goldwater Co.,15 B.T.A. 970">15 B.T.A. 970.
The petitioner did not own the Dreyfuss process in 1920, but in that year paid royalties to Dreyfuss for the use of it. As near as can be determined from the figures, it appears that the petitioner in 1920 paid Dreyfuss, in royalties, an amount equal to or greater than the estimated savings effected by the use of his process for the year. In other words, the petitioner paid for just about what it got from the use of the Dreyfuss process in 1920. We see no abnormality in this.
It was stipulated that the petitioner used borrowed capital in the*2178 amount of $108,095.41 in the conduct of its business, and the amount of salaries paid to its officers was also stipulated. But what is there to show whether this was a large or small amount of borrowed capital to be used by companies engaged like the petitioner in a business of this kind, or whether the salaries were high or low for such business? See Higginbotham-Bailey-Logan Co.,8 B.T.A. 566">8 B.T.A. 566; Mutual Oil Co. of Arizona,14 B.T.A. 538">14 B.T.A. 538; Wisconsin Butter & Cheese Co.,10 B.T.A. 852">10 B.T.A. 852; Bay Poplar Lumber Co.,12 B.T.A. 1367">12 B.T.A. 1367; Cramer & King, supra;Freedom Oil Works Co.,9 B.T.A. 823">9 B.T.A. 823; Kossar & Co.,16 B.T.A. 952">16 B.T.A. 952; Green, Matthews, Taylor Co.,19 B.T.A. 359">19 B.T.A. 359.
The petitioner has also alleged an error relating to the value of its good will. Apparently, the Commissioner has allowed a value for good will of $52,697 in the computation of invested capital. We have not been told how he arrived at this figure. We do not know whether or not good will was paid in for stock or what amount, if any, was expended for the acquisition or accumulation of good will. Consequently, *2179 we are unable to determine the amount at which good will should be reflected in the computation of invested capital. If the petitioner had good will of a value in excess of $52,697, perhaps it could, by proper proof, have established that its invested capital should be increased, and if it failed to produce proper proof, special assessment should not be granted. Edwin M. Knowles China Co., supra.Furthermore, we do not know what was the value of the petitioner's good will in 1920. The amount of the profit or loss of the company for each of the years 1909 to 1916, inclusive, was stipulated, and the parties also agreed that certain figures appear on the books of the company as representing the net tangible assets of the company on January 1 for each of the years 1909 to 1916, inclusive. But without more, and we have no more, we are unable to determine, compute, or even guess at the value of the petitioner's good will for the year 1920. Cf. Morris & Co.,1 B.T.A. 704">1 B.T.A. 704; Denver Powerine Co.,7 B.T.A. 1186">7 B.T.A. 1186.
*282 The petitioner also made an allegation relating to a contract under which it was operating as a basis for special*2180 assessment, but it introduced no evidence in support of the allegation. The petition also contained an allegation relating to a loss resulting from the abandonment of its plant in Charleroi, Belgium, at the beginning of the World War. The question of the petitioner's right to a deduction for this loss was decided when this case was originally presented to this Board. See Semon Bache & Co.,15 B.T.A. 183">15 B.T.A. 183. There is nothing in the evidence to show that this loss brought about an abnormal condition affecting capital or income to the corporation within the meaning of section 327. There is an allegation that a part of this loss could not be capitalized due to a faulty method of accounting. But no proof was offered to support this allegation.
Thus, we are of the opinion that no one of the conditions urged by the petitioner constituted an abnormal condition affecting the capital or income of the corporation within the meaning of section 327. Furthermore, we are of the opinion that these conditions considered as a whole did not constitute an abnormal condition within the meaning of this section.
Judgment will be entered for the respondent.