*916 This proceeding involves income and profits taxes for the fiscal years ended November 30, 1921 and 1922, in the sums of $68,055.42 and $5,227.30, respectively. Petitioner claims the benefit of sections 327 and 328, Revenue Acts of 1918 and 1921. For the fiscal years 1921 and 1922 the proper amount as a reserve for bad debts is in issue.
FINDINGS OF FACT.
Petitioner is a corporation organized under the laws of the State of Illinois, with principal office at 1233 West North Avenue, Chicago, Ill.
Petitioner's business was originally established by James S. Kirk in 1839, at Utica, N.Y., for the manufacture of laundry soaps principally. Although prospering at Utica, its founder determined in 1859 to move to Chicago, believing that the chances of growth and the procurement of raw materials would be better there. The business, which has been consistently prosperous, was run as a partnership under the name of James S. Kirk & Co. until 1900. In that year a corporation organized under the laws of New Jersey took over its assets. On March 28, 1906, petitioner*2221 was organized under the laws of Illinois with an authorized capital stock of $1,500,000, of which all but $91,400 was issued. The stockholders of the New Jersey corporation acquired all this stock, surrendering to petitioner the old corporation shares which they held and receiving others of the Illinois corporation of the same par value, which were issued under date of March 29, 1906. By the terms of a duly accepted offer made to petitioner by Milton B. Kirk, payment for the stock so issued was made by a transfer to petitioner of the assets and liabilities of the New Jersey corporation. The record books of said corporation contain, however, no reference to the sale or other disposition of its assets to the Illinois corporation. A meeting of the former's stockholders on March 29, 1906, was adjourned for want of a quorum.
All the personalty and realty of the New Jersey corporation was transferred to the Illinois corporation by two conveyances dated *917 March 30, 1906. Petitioners' balance sheet of March 31, 1906, correctly reflects its tangible assets of that date, except as to real estate and is as follows:
| Balance sheet as of March 31, 1906 | ||
| ASSETS | ||
| Current assets: | ||
| Cash | $90,473.83 | |
| Inventories | 538,320.00 | |
| Accounts receivable | 222,956.39 | |
| Board of trade membership | 1,500.00 | |
| London and Chicago Contract Corp. shares | 2,420.00 | |
| $855,670.22 | ||
| Fixed assets: | ||
| Real estate | 1 448,217.60 | |
| Buildings | 319,995.19 | |
| Machinery | 420,283.97 | |
| Loose tools, dies, etc | 73,205.88 | |
| Horses and vans | 14,610.80 | |
| Office furniture and fixtures | 6,854.09 | |
| Premium, furniture, and fixtures | 272.40 | |
| 1,283,439.93 | ||
| Miscellaneous assets (see contra): | ||
| Bad and doubtful accounts | 19,900.81 | |
| Bills receivable | 220,950.67 | |
| Sundry debtors | 19,419.19 | |
| Unexpired accounts | 24,675.17 | |
| Machinery suspense account | 5,296.54 | |
| Pine St. Blbd. expense | 750.00 | |
| Power & Glyc. Improv. in Const. | 134,160.72 | |
| 425,153.10 | ||
| Capital assets: | ||
| Treasury stock unsold | 91,400.00 | |
| Total assets | 2,655,663.25 | |
| LIABILITIES | ||
| Current liabilities: | ||
| Bills payable | 727,279.07 | |
| Accounts payable | 144,800.79 | |
| Reserve for taxes | 7,517.17 | |
| 879,597.03 | ||
| Capital liabilities: | ||
| Reserve for bad and doubtful accounts | 19,900.81 | |
| Reserve for unredeemed wraps | 7,595.23 | |
| Reserve for depreciation | 17,962.78 | |
| Authorized capital | 1,500,000.00 | |
| Surplus | 230,607.40 | |
| 1,776,066.22 | ||
| Total liabilities | 2,655,663.25 | |
*918 In 1874 the Kirk Co. developed a superior laundry soap which it has since been selling under the trade name of American Family Soap. In the manufacture of this product it has consistently used the same formula which calls for a high grade of tallows and a low percentage of resin. While a laundry soap, its quality is such that ten or twelve years ago it was sometimes used as a toilet soap. From about 1889 this laundry soap was the best seller in Chicago and Cook County. Hired help frequently insisted upon its use and this fact was generally recognized and commented upon by the Kirk Co.'s competitors prior to 1906. In the opinion of a consulting engineer familiar with the soap business in general and with petitioner's firm in particular since 1900, the brand was so intrenched in Chicago and vicinity in 1906 that no other brand could profitably be introduced. There was no store in Chicago without it. Although meeting spirited competition from laundry soaps of other firms prior to 1906, the brand successfully maintained its position as Chicago's best seller. Profits on it were sometimes as high as*2223 $1 or $1.50 a box, but these figures do not represent the average profit. Soaps called Chicago Family, Santa Claus, Amber, National Family, Federal Family, and others - some imitating the American Family brand in shape and size - were introduced by prominent soap manufacturers such as Proctor & Gamble, Fairbank, Swift & Co., Armour & Co., and others, but with the exception of Amber and Santa Claus, of which a few sales are still made, these brands had little success and have disappeared.
In 1899 the Kirk Co. developed a transparent toilet soap which it sold under the trade name of Jap Rose. In 1906 this was practically the only American transparent glycerin soap on the market. Although petitioner sometimes sold some of its brands at a loss, the above two always produced a profit.
About 1900 the Kirk Co., which had just been reorganized as a New Jersey corporation, initiated a campaign to increase the sales of the two brands in Cook County and outside territory where sales were very small. Jap Rose was introduced from Pittsburgh west to the coast as a starter. In this campaign magazines, newspapers, coupons, canvasses, painted boards, posters and jobbing salesmen were employed*2224 by the New Jersey corporation from 1900 to 1906, and the campaign was continued by petitioner until 1916, when the sales of American Family Soap reached a maximum. Petitioner's efforts were thereafter directed to a retention of its old business. In the City of Chicago efforts were made to get new customers by canvassers who approached housewives, offering the two brands for sale, or giving a coupon entitling the bearer to a bar free, or sometimes free upon the purchase of a bar. For advertising purposes *919 more was spent outside Chicago than in it, and from 1900 to 1909 there was an actual loss on every box of American Family Soap sold outside Cook County. The average amount so sold was one-fourth the amount sold in Cook County from 1900 to 1906. The total number of boxes of the American Family brand sold within and without, the total number of boxes of Jap Rose brand sold, aggregate sales, expenditures made for advertising, canvassing, and premiums, are as follows:
| American Family soap | ||||
| Years | Cook County | Outside of Cook | Jap Rose soap | Aggregate |
| (boxes) | County (boxes) | (boxes) | sales | |
| 1900 | 164,698 | 21,497 | ||
| 1901 | 178,772 | 44,460 | 29,376 | $2,190,902.73 |
| 1902 | 167,626 | 59,206 | 30,193 | 2,378,877.92 |
| 1903 | 175,174 | 75,526 | 47,242 | 2,371,139.70 |
| 1904 | 204,958 | 100,871 | 53,186 | 2,662,013.64 |
| 1905 | 203,575 | 96,408 | 52,493 | 2,429,027.35 |
| 1906 | 217,718 | 95,795 | 67,933 | 2,575,648.55 |
| 1907 | 217,501 | 84,666 | 80,513 | 2,793,307.73 |
| 1908 | 254,968 | 108,671 | 93,630 | 2,953,347.96 |
| 1909 | 287,923 | 124,667 | 121,368 | 3,873,989.37 |
| 1910 | 336,266 | 144,277 | 152,203 | 4,311,103.97 |
| 1911 | 375,536 | 173,512 | 153,575 | 5,159,088.56 |
| 1912 | 409,995 | 190,502 | 173,702 | 5,476,255.90 |
| 1913 | 442,947 | 204,036 | 169,526 | 6,350,087.81 |
| 1914 | 450,979 | 198,639 | 149,391 | 6,437,058.07 |
| 1915 | 512,722 | 199,478 | 164,185 | 7,472,242.78 |
| 1916 | 558,148 | 195,854 | 210,855 | 8,684,328.74 |
| Years | Advertising | Canvassing | Premiums |
| 1900 | $30,546.42 | ||
| 1901 | 120,564.26 | $50,002.37 | |
| 1902 | 141,778,86 | 37,897.07 | |
| 1903 | 106,110.95 | 50,888.09 | |
| 1904 | 204,756.22 | 97,822.26 | |
| 1905 | 191,498.78 | 72,494.94 | |
| 1906 | 178,973.09 | 72,296.10 | $36,877.88 |
| 1907 | 131,082.91 | 34,936.41 | 35,288.55 |
| 1908 | 163,913.53 | 32,620.28 | 48,045.60 |
| 1909 | 213,551.14 | 79,055.17 | 57,273.98 |
| 1910 | 217,553.29 | 77,891.25 | 62,914.94 |
| 1911 | 244,939.73 | 76,912.91 | 77,378.03 |
| 1912 | 343,226.28 | 100,902.52 | 90,427.23 |
| 1913 | 306,492.84 | 76,749.94 | 96,161.35 |
| 1914 | 288,746.56 | 36,376.02 | 93,375.08 |
| 1915 | 412,474.98 | 61,016.18 | 109,077.31 |
| 1916 | 363,147.22 | 35,793.22 | 96,870.20 |
The advertising, canvassing and premium expenses were charged off each year, and no asset as a result of them was set up. The premiums were given primarily to retain old business. No value for good will has ever been entered on petitioner's books.
On account of a loss of records, profits of the Kirk Company prior to 1900 could not be shown; books of the business since 1900, however, are complete. The following tabulation prepared by petitioner's auditor from the books of its predecessor shows the*2226 annual profits of the New Jersey corporation:
| 1900 | $8,358.91 |
| 1901 | 132,334.12 |
| 1902 | 21,728,81 |
| 1903 | $158,906.37 |
| 1904 | 223,260.09 |
| 1905 | 121,936.85 |
In 1906 the business earned $23,502.02; three months of this period was allocable to the New Jersey corporation.
The value, in 1906, of the American Family brand has been variously estimated to be between $500,000 and $1,000,000; of the Jap Rose brand, between $150,000 and $250,000; and these, together with the Kirk Co. name, between $1,000,000 and $2,000,000.
Since incorporation petitioner has maintained on its books a reserve for bad debts. For the taxable year 1921 there was allowed *920 an addition to this reserve of $14,000, which was a considerable increase over additions to the reserve in prior years. In computing net income for that portion of the taxable year 1921 falling under the provisions of the 1918 Act, petitioner was allowed a deduction of $19,530.96 for bad debts and for the portion falling under the 1921 Act was allowed as a deduction a reserve for bad debts in the amount of $14,000. For the taxable year 1922 petitioner was allowed a reserve for bad debts in the amount of $25,266.26. *2227 The following schedule of petitioner's income-tax return is a correct reflection of entries regarding bad debts on the books of the company:
| SCHEDULE A17 - BAD DEBTS | |
| Year ended November 30th, 1921 | |
| Bad debts arising from sales prior to 12/1/20 and charged direct to profit and loss | $11,799.08 |
| Addition to reserve account during year ended 11/30/21 | 14,000.00 |
| Uncollectible employes note made in 1919, written off to profit and loss | 100.00 |
| Uncollectible freight claim of 1918 written off to profit and loss | 329.46 |
| Amount used as deduction on tax returns | 26,228.54 |
| Bad debts amounting to $7,302.42 arising from sales made during the year ended Nov. 30-1921 and charged direct to profit and loss account have been treated as an unallowable deduction and the addition to the Bad Debt Reserve account of $14,000.00 used as an expense for the taxable year. | |
| RECONCILIATION OF BAD DEBT RESERVE ACCOUNT | |
| Reserve account at Dec. 1-1920 | 6,000.00 |
| Addition to reserve account for year ended 11/30/21 | 14,000.00 |
| Balance per Balance Sheet at Nov. 30-1921 | 20,000.00 |
| Net sales for year ended Nov. 30-1921 | 9,505,633.31 |
| Percentage of addition to reserve account of $14,000.00 to sales | .0015 |
| Total of accounts and notes receivable at 12/1/20 | 694,004.42 |
| Total of accounts and notes receivable at 11/30/21 | 607,580.17 |
*2228 For the taxable year 1921 two returns were prepared - one under the 1918 Act and the other under the 1921 Act. The following schedule from the return under the 1918 Act also reflects the entries in the books with respect to the charging off of bad debts for the taxable year 1921:
| SCHEDULE A17 - BAD DEBTS | |
| Year ended November 30th, 1921 | |
| Miscellaneous arising from sales previously reported as income | $19,101.50 |
| Uncollectible employes note | 100.00 |
| Uncollectible freight claims | 329.46 |
| 19,530.96 | |
*921 The following figures represent bad debts charged off by petitioner for the years indicated:
| 1921 | $19,052.91 |
| 1922 | 20,064.06 |
| 1923 | 34,094.21 |
| 1924 | 15,959.90 |
| 1925 | $14,075.22 |
| 1926 | 22,261.62 |
| 125,507.92 |
Since 1920 petitioner has gradually increased its sales direct to retailers rather than making them through jobbers, and as a consequence incurs more losses from bad debts. This change was brought about largely by the appearance of chain stores.
OPINION.
STERNHAGEN: From all of the foregoing facts, we think it clear that petitioner's statutory invested capital could not be satisfactorily determined and that it is therefore*2229 within section 327 and entitled to have its profits tax determined by the special assessment method of section 328.
As to the bad debt deduction for each of the years in question, the petitioner's evidence is not sufficient to establish the reasonable addition to the reserve to be deducted, and the respondent is in this respect sustained.
The parties may proceed further under Rule 62.
Footnotes
1. $300,018.40 should be added to the value of real estate. ↩