*2050 1. Rate of depreciation approved.
2. Special assessment denied.
*702 The petitioner in this proceeding seeks a redetermination of deficiencies in income and profits taxes for the years 1920 and 1921 in the sum of $915.06 and $2,374.56, respectively. Two issues are presented, namely, (1) the correct rate to be used to determine the allowance for exhaustion, wear and tear of machinery and equipment, and (2) whether or not during the taxable years petitioner's income and capital were so affected by abnormal conditions within the provisions of section 327 of the Revenue Acts of 1918 and 1921 as to entitle it to have its taxes determined under the provisions of section 328 of said acts.
With respect to the second issue, the hearing was limited under the provisions of Rule 62(b) of the Board's rules of practice.
*703 FINDINGS OF FACT.
Petitioner is a corporation incorporated in 1916 under the laws of the Commonwealth of Pennsylvania. It issue capital stock in the sum of $15,000, each share being*2051 of the par value of $100. The petitioner was engaged in manufacturing tapestry for use as furniture covering and interior decoration, and for novelty goods such as table scarfs and drapery materials. The tapestry was woven from cotton, wool, and artificial silk.
The business carried on by petitioner was founded by James Newton in 1899 with a capital of $2,100 and he operated it individually until his death in 1914. During these years his three sons were employed by him for the following periods: William H. Newton from 1904 to the date of his father's death; James F. Newton from 1908 to the date of his father's death; and John R. Newton from 1912 to the date of his father's death. While in business with their father all three sons became expert workmen in various branches of the business of manufacturing tapestry.
By his last will and testament James Newton, the father, bequeathed his tapestry business to his three sons and two daughters in equal shares. For two years after the testator's death the business was carried on by his executrix. In 1916 it was incorporated. Before its incorporation H. B. Newton, a brother of James Newton, Sr., bought the interest bequeathed to*2052 the two daughters of the founder of the business.
The stock of the corporation, the petitioner herein, was subscribed for as follows:
| Shares | Amount | |
| H. B. Newton | 60 | $ 6,000 |
| William H. Newton | 30 | 3,000 |
| James F. Newton | 28 | 2,800 |
| John R. Newton | 32 | 3,200 |
| 150 | 15,000 |
The stock was held by the same persons in the same amounts in the years 1920 and 1921. One thousand five hundred dollars in cash was paid in for the stock and the balance was paid for by the transfer to the petitioner of title to the machinery, equipment, and other assets of the business founded by James Newton, Sr. None of the stock was issued in exchange for the good will of the business, although the good will was valuable because of the experience and standing of James Newton and his sons in the tapestry-manufacturing business.
*704 The machinery used by petitioner for the manufacture of tapestry during the years in question consisted of 7 warping mills, 40 fancy unholstery looms, together with about the same number of Jacquard machines, 18 overlocking machines, 12 sewing machines and various finishing machines. A weaving unit consisted of a loom and a Jacquard machine. *2053 The material used in the manufacture of the tapestry was received in petitioner's mill in skeins. The skeins, after being dyed the desired colors, were processed in the warping mills before being woven by the looms. After being put through various finishing processes the material was given a finished edge by use of the overlocking machines and the sewing machines.
Most of the machinery used by petitioner in 1920 was secondhand, having been purchased from other manufacturers of tapestry. During 1921 the petitioner enlarged its plant and acquired 18 new looms, two additional secondhand looms, 9 new Jacquard machines, and certain other new machinery. Parts of the Jacquard machines were replaced every 2 years and the machines were totally scrapped at the end of 7 years. None of the looms used by petitioner in 1920 and 1921 were in use at the date of the hearing herein. During the years in question all of the repairs and necessary replacements to the machines were charged to ordinary and necessary expense.
In 1920 and 1921 William H. Newton was president and secretary of petitioner, James F. Newton, vice president, and John R. Newton, treasurer and general manager. From January 1, 1920, to*2054 May 27, 1920, the treasurer and general manager, John R. Newton, received salary at the rate of $2,600 per year and the other officers received a less amount. On May 27, 1920, the directors of petitioner determined the salaries of officers as follows:
| William H. Newton, president and secretary | $ 3,400 |
| James F. Newton, vice president | 3,400 |
| John R. Newton, treasurer and general manager | 4,000 |
In May, 1921, salaries were voted by the directors as follows:
| William H. Newton, president and secretary | $4,680 |
| James F. Newton, vice president | 4,680 |
| John R. Newton, treasurer and general manager | 5,200 |
The following amounts were paid as salaries to the officers during the years 1920 and 1921:
| 1920 | 1921 | |
| William H. Newton | $3,297.02 | $4,162.98 |
| James F. Newton | 3,267.02 | 4,162.98 |
| John R. Newton | 3,824.68 | 4,714.32 |
| 10,370.72 | 13,041.28 |
*705 In addition to performing his duties as president and secretary during 1920 and 1921, William H. Newton acted as plant superintendent. He also frequently performed the duties of a warper. By training he was a color harmony man, an artist, and did all the color harmony work for petitioner*2055 during the years 1920 and 1921. The duty of a color man is to see that the colors of the tapestry harmonize after the designs are made. During the years in question petitioner employed no special color man. The salary of a regular color man during 1920 and 1921 was at least $5,000 per year, some of the largest factories in the tapestry business paying as much as $15,000 per year. The wages of a warper were $50 per week.
James F. Newton, who was the vice president, not only performed his duties as such during 1920 and 1921, but also worked in the finishing department of the mill, overseeing the finishing of the merchandise after it left the looms, examining it for defects, and supervising its shipment to customers.
The treasurer and general manager, John R. Newton, had charge of the office work, handled the salesmen on the road, purchased all raw materials, and attended to the finances of the petitioner. He also purchased all replacements for the machinery and supervised their installation.
In the manufacture of tapestry, after the material has left the warping mills it has to be twisted by hand before it can be woven by the looms. During the years 1920 and 1921 the wages*2056 of a twister were $48 per week. William H. Newton and James F. Newton were skilled twisters and themselves performed this work during the years in question instead of employing other skilled labor for that purpose. The mill was a closed shop, operated under union rules. Under union rules two loom fixers were required to be employed in a mill having the number of looms which were operated by petitioner. The wages of a loom fixer were $56 per week. The three Newton brothers, however, did whatever loom fixing was necessary in petitioner's plant during 1920 and 1921. Under union rules they were permitted to perform this service, as well as the other skilled services herein referred to, because they were considered the owners of the business.
In the years in question the business of petitioner increased greatly in volume and value. To meet the demand for its product the petitioner's mill was operated overtime continuously during both years. It was operated an average of 62 hours per week instead of 48 hours, which was the normal number of weekly working hours under union rules. During this period the regular working hours of the three Newton brothers were from 7.30 or 8 a.m.*2057 to 7 or 8 p.m. At least one of the three always stayed at the mill until about 10 p.m. They took turns in such overtime work.
*706 The petitioner's invested capital at the beginning of 1920, as determined by respondent, was $43,910.58, and its net income for the year was $22,033.49. Its invested capital at the beginning of 1921, as stated by respondent, was $65,046.72 and its net income for the year was $76,866.18. At the beginning of 1920 petitioner owed $19,800 for money borrowed. Of this amount $12,800 had been borrowed from members and friends of the Newton family and the balance of $7,000 from a bank. During 1920, $48,600 was borrowed and $35,000 was paid on account of loans. During 1921 petitioner borrowed $55,100 and paid $66,500 on account of its outstanding loans.
Petitioner's balance sheet as of December 31, 1920, is as follows:
| ASSETS | |||
| Current assets: | |||
| Cash on hand and in bank | $ 9,482.22 | ||
| Liberty bonds | 800.00 | ||
| Notes and accounts receivable: | |||
| Notes receivable | $ 375.00 | ||
| Accounts receivable | 35,572.52 | ||
| 35,947.52 | |||
| Inventories: | |||
| Merchandise | 30,798.72 | ||
| Supplies | 1,278.08 | ||
| 32,076.80 | |||
| $ 78,306.54 | |||
| Prepaid assets: | |||
| Unexpired insurance | 500.00 | ||
| Fixed assets: | |||
| Machinery and fixtures | 26,704.99 | ||
| Cards and designs | 3,490.64 | ||
| 30,195.63 | |||
| 109,002.17 | |||
| LIABILITIES | |||
| Current liabilities: | |||
| Notes payable | 33,400.00 | ||
| Accounts payable | 3,776.73 | ||
| Sundries payable | 859.31 | ||
| 38,036.04 | |||
| Capital accounts: | |||
| Capital stock | 15,000.00 | ||
| Surplus | 55,966.13 | ||
| 70,966.13 | |||
| 109,002.17 |
*2058 Petitioner's balance sheet as of December 31, 1921, is as follows:
| ASSETS | |||
| Current assets: | |||
| Cash on hand and in bank | $17,263.64 | ||
| Liberty bonds | 800.00 | ||
| Notes and accounts receivable: | |||
| Notes receivable | $1,017.06 | ||
| Accounts receivable | 82,323.85 | ||
| $83,340.90 | |||
| Inventories: | |||
| Merchandise | 62,322.92 | ||
| Supplies | 930.26 | ||
| 63,253.18 | |||
| $164,657.72 | |||
| Prepaid assets: | |||
| Unexpired insurance | 700.00 | ||
| Fixed assets: | |||
| Machinery and fixtures | 37,739.50 | ||
| Cards and designs | 1,898.89 | ||
| 39,638.39 | |||
| 204,996.11 | |||
| LIABILITIES | |||
| Current liabilities: | |||
| Notes payable | 22,000.00 | ||
| Accounts payable | 29,001.57 | ||
| Sundries payable | 16,204.69 | ||
| 67,206.26 | |||
| Capital accounts: | |||
| Capital stock | 15,000.00 | ||
| Surplus | 122,789.85 | ||
| 137,789.85 | |||
| 204,996.11 |
*707 The respondent disallowed petitioner's claim that a rate of 10 per cent per year should be used in determining depreciation for the years in question and allowed a rate of 7 1/2 per cent. Respondent also disallowed petitioner's request for special assessment under the provisions of sections 327 and 328 of the Revenue Acts of 1918 and 1921.
OPINION.
VAN FOSSAN: The first issue*2059 is with respect to a rate to be used in computing the allowance for exhaustion, wear and tear of petitioner's machinery during the years 1920 and 1921.
In our opinion the evidence is not of sufficient weight or definiteness to overcome the presumption that the respondent's computation of the amounts referred to was correct.
The testimony with respect to the number of hours weekly the machinery was operated during the period in question is contradictory. On direct examination petitioner's treasurer, who was the only witness testifying concerning the condition of the machinery, stated that during all of the taxable years the petitioner's tapestry mill was operated regularly both day and night in two shifts of work, the day shift working 48 hours per week and the night shift working 44 hours per week. On cross-examination this witness *708 testified that the work of the mill during the taxable year was not done in two shifts, but that the mill was operated an average of 62 hours per week, namely 14 hours per week more than the regular working time fixed by union rule, and that this operation was accomplished by overtime work. The evidence shows that a majority of the machinery*2060 in use in 1920 was secondhand when bought by petitioner, but it does not appear how long this machinery had been in use when petitioner purchased it or its physical and mechanical condition at that time. Nor is there any evidence of the total cost of the secondhand machinery nor of the specific items comprising it. The treasurer testified that about 40 looms were owned and operated by petitioner at all times during the taxable years. Although it appears that 18 new looms and 2 secondhand looms, together with certain other new machinery and equipment, were purchased in 1921, because of the extension of the plant, there is no evidence from which it can be determined whether the 18 new looms and 2 secondhand looms were used with the 40 looms already in operation or whether some of the 40 looms were discarded at the time of the purchase of the new looms. The estimates of the useful life of the several types of machinery made by the petitioner's treasurer were largely in general terms. He testified that it was his opinion, growing out of his experience, that the average useful life of the various types of machinery used by the petitioner was ten years. There are in evidence only a*2061 few explicit and detailed figures by which the treasurer's estimate can be tested. There are figures from which it might be found that the average useful life of machines and equipment purchased in 1921 was 13 years, but not all the types of machines used by petitioner were included in the purchases made in 1921, and it appears that some of the machines not included in such purchase had an average useful life estimated at from 25 to 30 years.
Considering the evidence in relation to this issue as a whole, we can not say that the rate of 7 1/2 per cent per annum used by the respondent for the determination of the allowance made for exhaustion, wear and tear of machinery is not a fair and reasonable rate.
Petitioner's claim that during the taxable years its income and capital were affected by abnormal conditions, within the provisions of section 327 of the Revenue Acts of 1918 and 1921, is based on the following grounds:
1. That the petitioner on its incorporation acquired the good will of the business founded by James Newton without payment therefor either in stock or by other valuable consideration and that this good will was a valuable asset not included in invested capital.
*2062 2. That during the taxable years the petitioner employed in its business relatively large amounts of borrowed money and that this borrowed money contributed to the production of taxable net income.
*709 3. That because of the skilled services which petitioner's officers rendered, in addition to their ordinary duties as such officers, the petitioner was saved a very considerable amount of deductible expense for wages and that net income for the taxable years was thereby increased by the amount so saved.
The pertinent parts of section 327 of the Revenue Acts of 1918 and 1921 are as follows:
SEC. 327. That in the following cases the tax shall be determined as provided in section 328:
* * *
(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 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*2063 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 * * *.
Since no stock was issued in exchange for the good will of the business acquired by petitioner from beneficiaries of the estate of James Newton, whatever value the good will had in 1920 and 1921 is necessarily excluded from invested capital under the provisions of section 306 of the Revenue Acts of 1918 and 1921. There is no proof of the value of the good will, nor of its relation either to invested capital or to the production of net income during the taxable years in question. It can not be said that statutory exclusion from invested capital of itself creates an abnormality giving rise to the right of special assessment within the provisions of sections 327 and 328 of the applicable revenue acts. ; ; *2064 .
Nor do we consider that petitioner's use of borrowed money during the taxable years created an abnormality within the provisions of the statute. In the beginning of the year 1920 petitioner owed $19,800 for borrowed money. In that year it borrowed $48,600 additional; it paid off some of its borrowings and at the end of the year its balance sheet contained among the stated liabilities the sum of $33,000 on account of notes payable. In 1921 petitioner borrowed $55,100 and at the end of that year it owed $22,000 on account of notes payable. During the two years petitioner's gross sales were rapidly increasing, amounting to $331,631.58 in 1920 and to $596,989.16 in 1921. Petitioner's invested capital at the beginning *710 of 1920 was $43,910.58 and its net income for the year was $22,033.49. At the beginning of 1921 its invested capital was $65,046.72 and its net income for that year was $76,866.18. It does not appear from any proof in the record that it was not customary and normal for concerns engaged in business similar to that of petitioner to borrow considerable sums of money to finance*2065 their operation. What is abnormal can be determined only by reference to what is normal. On this principle we have consistently held that the use of borrowed capital is not in itself evidence of an abnormality, but that the claimed abnormality must be established clearly by the proof. ; ; ; .
The salaries paid to petitioner's officers amounted to the total sum of $10,370.72 in 1920 and to the total sum of $13,041.28 in 1921. The petitioner does not claim that the amounts of salaries were inadequate payment for the performance by the officers of the duties usually pertaining to their respective offices. But petitioner argues in effect that its officers performed skilled labor for which they were not paid and that the special skilled work done by them, as stated in the findings of fact, effected a saving of comparatively large amounts which otherwise petitioner would have had to pay as salary and to net income essentially different in character from that which any in*2066 the net income of the taxable years and that the condition created thereby is abnormal.
It is not unusual for the officers of a corporation to endeavor to save expenses of operation wherever and however such saving may be made without curtailing efficiency of operation. Curtailment of expenditure in any business might be reflected in profit, if the business shows a profit. The fact that the training and experience of petitioner's officers enabled them to make a saving in petitioner's salary and wages account did not create a condition with respect to net income essentially different in character from the which any wise saving in other operating expense would have created. And, in the last analysis, it must be considered that the salaries paid to the officers were payment for all services performed by them of whatever nature. It may be that the salaries paid were inadequate, judged from the point of view of total services rendered by the officers of the petitioner. We have held, however, that mere inadequacy of salary does not, of itself, create abnormality. *2067 ; . Moreover, the aggregate of a number of conditions, each inadequate in itself, does not necessarily constitute a basis for special assessment.
*711 For the reasons stated we are of the opinion that petitioner is not entitled to special assessment under the provisions of sections 327 and 328 of the Revenue Acts of 1918 and 1921.
Decision will be entered for the respondent.