*2403 Where the basis for the computation of the gain on the sale of a factory is the March 1, 1913, fair market value, such value may be an amount in excess of the residual value of the tangibles, depending upon the earnings over a series of years and other relevant factors.
*416 This is a proceeding for the redetermination of a deficiency in income and profits tax for 1920 of $11,630.64. The only point in issue is the amount of profit, if any, realized by the petitioner upon the sale of a paper-box factory in 1920 for $150,000 cash, which profit the Commissioner has determined amounted to $82,095.14. The petitioner contends that in his computation the Commissioner has allowed no amount for the good will or going-concern value of the factory at March 1, 1913, which it claims was not less than $73,689.75.
FINDINGS OF FACT.
The petitioner is a Connecticut corporation engaged in the manufacture and sale of paper boxes. In 1920 it had in operation factories in Bridgeport, Waterbury, New Haven, *2404 and Naugatuck. The Naugatuck factory burned in 1902 and a new factory building was erected. From a period prior to 1902 until 1920, 95 per cent of the business of the Naugatuck factory was derived from the sale of paper boxes to the Goodyear Metallic Rubber Shoe Co. and to the Goodyear India Rubber Cloth Co., which, prior to 1920, became subsidiaries of the United States Rubber Co. These concerns are located at Naugatuck. The Naugatuck factory was not built to carry on a general paper-box-manufacturing business, other factories of the petitioner being equipped for that purpose. These other factories were located at a distance of from six to twenty-six miles from the Naugatuck factory. When the Naugatuck factory was rebuilt in 1902, machinery especially designed for the manufacture of boxes for the two rubber companies was installed. Every machine in the factory was scientifically constructed for the production of boxes used by the rubber companies. If the Naugatuck factory had ceased doing business with the rubber companies, not more than two *417 machines in it could have been utilized in the other factories of the company.
The Naugatuck factory was run independently*2405 of the other factories and had a separate accounting system. It was charged with a proportionate share of certain overhead expenses such as officers' salaries. The business done with the rubber companies was secured and conducted under a series of five-year contracts. On March 1, 1913, the business was being carried on under two contracts entered into in 1910, which expired on March 1, 1915. On September 24, 1914, another five-year contract was entered into between the petitioner and the rubber companies, effective April 1, 1915, and covering a period of five years. This contract stipulated that the rubber companies would purchase their entire supply of paper boxes during the five-year period from the petitioner at prices fixed in the contract.
The value of the Naugatuck factory materially increased in 1920 over 1913, on account of the war and the resulting increase in construction costs and in business.
The prices of materials and labor at about the expiration of the five-year contract effective April 1, 1915, were chaotic. It became impracticable to enter into another contract covering a five-year period. In this situation negotiations were entered into in 1919 between*2406 the United States Rubber Co. and the petitioner for the purchase by the former of the Naugatuck factory. The rubber company believed that it would be more advantageous and profitable for it to take over the factory and make its own paper boxes than to buy them from White & Wells. It was not the intention of the rubber company to go into the paper-box business or sell boxes to the public, but merely to manufacture them for use in its own business.
The dealings between the rubber companies and White & Wells had always been carried on at arm's length. From time to time the rubber companies sent out feelers to other rubber companies at Bridgeport and New Haven to see what arrangement could be made with them for the manufacture of paper boxes which they needed and which were than being manufactured by the petitioner at its Naugatuck factory.
The five-year contract of September 24, 1914, effective April 1, 1915, expired March 31, 1920, before negotiations for the purchase by the United States Rubber Co. of the Naugatuck factory had been concluded. Thereafter business was conducted between the Naugatuck factory and the United States Rubber Co. on a month to month basis. In 1920*2407 the rubber company made an offer to buy the Naugatuck factory for $50,000. On April 21, 1920, the petitioner refused the offer of $50,000 and made a counter offer to sell for $150,000 and *418 notified the United States Rubber Co. that if this offer were not accepted it would forthwith discontinue the manufacture of paper boxes for the rubber company. The rubber company carefully considered the situation and on May 24, 1920, a contract of sale was entered into between the petitioner and the United States Rubber Co., by which the petitioner sold to the rubber company its Naugatuck factory for $150,000 cash. The contract provided that the seller agreed to transfer the land on which the factory stood:
* * * TOGETHER WITH all the buildings and the entire plant and structures; also all chattels in and about said plant and premises including factory equipment, machinery, tools and appliances, office furniture and fixtures, stock on hand and in process of manufacture, merchandise and raw materials, operated and used in connection with the said plant and factory, more particularly specified in the schedule attached hereto and made a part hereof. * * *
Under the contract of sale*2408 it was planned that the petitioner should withdraw from the factory on a Saturday night and that the United States Rubber Co. should commence its operation of the factory the following Monday morning. No time was to be lost in the manufacture of paper boxes and the petitioner was to turn over its complete organization of operatives, in so far as it was within its power to do so. This plan was in fact carried out and the petitioner's business, its land, buildings, machinery, and equipment were sold and delivered as a going concern in full operation and production. Thereafter the petitioner made no more boxes for the United States Rubber Co. or its subsidiaries.
The tangible assets belonging to the Naugatuck factory of the petitioner at the beginning of each of the five calendar years immediately preceding March 1, 1913, had the following values:
| 1908 | $61,235.93 |
| 1909 | 57,061.72 |
| 1910 | 57,231.79 |
| 1911 | 60,714.62 |
| 1912 | 53,946.99 |
| Total | 290,191.05 |
The net earnings of the factory for each of the five calendar years immediately preceding March 1, 1913, were as follows:
| 1908 | $38,549.98 |
| 1909 | 28,104.60 |
| 1910 | 16,555.63 |
| 1911 | 806.99 |
| 1912 | 18,691.67 |
| Total | 102,708.87 |
*2409 In its income-tax return for 1920, the petitioner reported a profit upon the sale of its Naugatuck factory of $52,471.13. This was based *419 upon the difference between the $150,000 cash received on the sale and $97,528.87, the residual value of the tangibles of the Naugatuck factory as computed by the petitioner. The Commissioner rejected the method of computation used by the petitioner in determining the residual value of the tangibles and in lieu thereof found a value of $67,904.86. By this method of computation the Commissioner determined a profit upon the sale of $82,095.14. The petitioner does not challenge the correctness of the Commissioner's determination that the residual value of the tangibles at the date of sale was $67,904.86.
OPINION.
SMITH: The only point in issue in this proceeding is the amount of profit realized by the petitioner upon the sale of its Naugatuck factory in 1920 for $150,000. The respondent has determined the amount of the profit to be $82,095.14. He contends that the residual value of the tangibles at the date of sale was $67,904.86 and that the amount received in excess of that amount constitutes profit. The petitioner does not*2410 challenge the correctness of the respondent's determination of the residual value of the tangibles, but contends that to such value should be added the good will or going-concern value of the Naugatuck factory on March 1, 1913, which it contends was at least $73,689.75. The calculation by which the petitioner reaches this result is as follows:
| Total value of net tangible assets for 5-year period, 1908-1912 | $290,191.05 |
| Average yearly value of net tangible assets | 58,038.21 |
| Total net earnings for 5-year period | 102,708.87 |
| Average yearly net earnings | 20,541.77 |
| Deduct: 10 per cent return on average net tangible assets | 5,803.82 |
| Average yearly earnings attributable to intangible assets | 14,737.95 |
| Multiply to capitalize on a 5-year purchase | 5 |
| Value of petitioner's good will on Mar. 1, 1913 | 73,689.75 |
The pertinent provision of the applicable statute is section 202(a) of the Revenue Act of 1918, which provides, so far as material, as follows:
That for the purpose of ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, the basis shall be -
(1) In the case of property acquired before March 1, 1913, the*2411 fair market price or value of such property as of that date; * * *
In support of its contention that the going-concern value of its Naugatuck factory should be taken into account in determining the March 1, 1913, value thereof the petitioner relies upon the decision of the Circuit Court of Appeals for the Second Circuit in . In that case the *420 vendor corporation sold its plant in 1919 to the English & Mersick Co. and went out of business. The question before the court was the March 1, 1913, value of the property sold. The Government contended that to the residual value of the tangibles there should be added nothing for the good will or going concern value at March 1, 1913, for the reason (1) that the vendor had no good will to sell; (2) that if it had such good will such good will was not sold; (3) that if good will existed and was sold, there was no proof of its value as of March 1, 1913; and (4) that no proof was made of the original cost of such good will and that such proof was necessary. All of the contentions of the Government were overruled by the court. The principal contention of*2412 the Government appears to have been that inasmuch as the vendor corporation manufactured goods for a sole customer no good will could attach to the business. The evidence was held to show that the vendor corporation possessed good will on March 1, 1913, and on the date of the sale of its factory in 1919, though practically all of its products were purchased by one customer. "Good will" was held to mean every possible advantage acquired by the old firm in the progress of its business, whether connected with debts, business, or with the name of the old firm, or with any matter carrying with it benefit of business.
In this proceeding the respondent attempts to differentiate the Pfleghar Hardware Specialty Co. case from the instant case since in the former the company sold its plant and went out of business, whereas, in the instant proceeding, the petitioner sold only one of its factories and continued in the general paper-box business. It is further contended that the United States Rubber Co. did not buy the good will of the petitioner or of the Naugatuck factory because the Naugatuck factory was designed especially for manufacturing supplies for the rubber company; that it*2413 was not necessary for the rubber company to buy any good will of the plant.
We are of the opinion that there is no sound basis for distinguishing the instant case from that of the Pfleghar Hardware Specialty Co. case. The question before us here is the fair market value of the Naugatuck factory as a going concern on March 1, 1913. The evidence indicates that it was operating at a good profit and we are by no means persuaded that the factor of profitable operation should not be taken into account in computing the fair market value. It is to be assumed that a manufacturer doing a profitable business will not sell his plant at any date for the residual value of its tangibles. The Commissioner also contends that the petitioner did not sell any good will when it sold its Naugatuck factory. We believe that it did. The record indicates that the petitioner had been doing a profitable business with the United States Rubber Co. or its subsidiaries for a *421 long period of years. Such a business relationship had value. Our concern here is the determination of that value. Petitioner contends that that value on March 1, 1913, was $73,689.75. We have above set out the formula*2414 by which it reaches such valuation. The respondent criticizes this formula for the reason that two years of the period of operation, namely, 1908 and 1909, were under contracts antedating the contracts of 1910 and that the operating results of those two years are not a criterion in the determination of the March 1, 1913, value. We think this criticism is sound. Presumably, the rubber companies in the making of the contracts of 1910 either obtained better prices from the petitioner or else the costs of operation under the contracts effective April 1, 1910, were less advantageous to the petitioner.
We are of the opinion that the determination of the going-concern value of the petitioner on March 1, 1913, should be predicated upon operating results covering the years 1910, 1911, and 1912 and exclude the results obtained under the earlier contract in February for the years 1908 and 1909.
From a consideration of the entire record we reach the conclusion that the going-concern value of the petitioner's Naugatuck factory on March 1, 1913, was the amount of $31,441.60, which amount, added to the residual value of the tangibles of $67,904.86, gives a basis for the determination of*2415 the profit upon the sale of the Naugatuck factory of $99,346.46. Since such factory was sold in 1920 for $150,000 cash, the profit realized upon the sale was $50,653.54.
Judgment will be entered under Rule 50.