*4221 1. Value of contract paid in for stock and cash, determined.
2. Where a contract secures to a corporation the services of an individual for 10 years and also gives a permanent exclusive right to the use of his name and the value has not been allocated between the two features, no yearly deduction for exhaustion of the contract is allowable.
3. Assessment and collection of 1919 tax held barred.
*1391 These are proceedings, consolidated for hearing and decision, for the redetermination of deficiencies for the calendar years 1919 and 1921, asserted by the respondent in the respective amounts of $40.28 and $3,981.28. The issues are (1) the value of a contract for purposes of invested capital and depreciation; (2) whether depreciation deductions are allowable on such contract for the years in question; (3) whether petitioner is entitled to have its tax computed for both years under the special assessment provisions of the Revenue Acts of 1918 and 1921; and (4) whether the Assessment and collection of the 1919*4222 deficiency is barred by the statute of limitations.
FINDINGS OF FACT.
The petitioner is a Michigan corporation with its factory and principal office at Holland, Mich. It was organized August 10, 1906, to manufacture and deal in furniture and furniture supplies. It acquired and continued a business theretofore developed and operated as a partnership in Grand Rapids, Mich., under the name of Charles P. Limbert & Co. The partnership had been begun as a selling arrangement and was extremely successful. After three or four years they had entered into the manufacturing business, producing, largely, outside furniture for lawns and porches. At that time, C. P. Limbert, the dominating personality in the business, developed the name "Limbert's Arts and Crafts." Prior to the time C. P. Limbert entered into the manufacturing business, furniture from Grand Rapids was sold entirely by photograph and traveling salesmen on the road. He inaugurated a new method of opening sales rooms for the display of various manufactured lines. In 1905, the City of Holland, Mich., made a very attractive offer to Charles P. Limbert & Co. to locate in that city, offering to donate and build a large plant*4223 to C. P. Limbert's specifications on the understanding that a certain number of men would be employed for a certain time. The offer was accepted and petitioner's plant and offices were moved to that city.
Charles P. Limbert was known as an originator; was very aggressive and popular with the furniture trade. He first entered into the furniture field as a traveling salesman. He introduced into the furniture business a number of very successful innovations and the product of his factory was outstanding in many respects, being acknowledged as a leader in the particular lines manufactured.
When the petitioner corporation was organized in 1906, it took over all of the stock of furniture, materials, machinery, tools, heating, light equipment, and buildings owned by Charles P. Limbert & Co. in exchange for petitioner's stock of the par value of $41,402.10, the book value of such assets. Additional stock purchased by the incorporators *1392 for cash at par brought the outstanding par stock value to $55,000 at the date of incorporation. The schedule of assets and liabilities thus acquired by petitioner at the time of its organization is as follows:
| Assets: | ||
| Furniture and fixtures | $2,063.65 | |
| Machinery and tools | 7,982.50 | |
| Power, heat, and light equipment | 3,282.15 | |
| Buildings on said block | 28,190.05 | |
| Bark and cane | 1,284.95 | |
| Finishing material | 327.78 | |
| Hardware | 264.03 | |
| Insurance | 259.10 | |
| Lumber | 5,881.36 | |
| Merchandise | 32,942.36 | |
| Trimming materials | 452.21 | |
| Upholstering materials | 1,536.89 | |
| Miscellaneous material | 2,255.35 | |
| Accounts receivable | 15,287.74 | |
| 102,010.02 | ||
| Liabilities: | ||
| Bills payable | $42,441.73 | |
| Accounts payable | 5,666.19 | |
| Mortgage | 12,500.00 | |
| 60,607.92 | ||
| Net worth for stock issue | 41,402.10 |
*4224 No good will on other intangible assets was entered on petitioner's books at the time of its incorporation when the above exchange was made.
In 1911, Charles P. Limbert was the owner of more than two-thirds of the $55,000 total par stock of the petitioner outstanding, and under the Michigan statutes the voter of two-thirds of the stock can change the name of the corporation. Despite the successful growth of petitioner's business, C. P. Limbert was dissatisfied with his remuneration in the form of compensation and stock earnings from the petitioner and believed that it would be possible to earn more money as a free selling agent, than as a manufacturer. He considered, very seriously, withdrawing from the corporation after changing its name, and embarking in the selling business for himself. In order to induce him not to take such action, a contract was entered into between Charles P. Limbert and the petitioner by which, for a consideration of $25,000 cash and $45,000 par value stock of the Charles P. Limbert Co., Charles P. Limbert agreed to do a number of things. The contract is as follows:
MEMORANDUM OF AGREEMENT, Made this 17th day of October, 1911, between CHARLES P. *4225 LIMBERT COMPANY, a corporation, party of the first part, and CHARLES P. LIMBERT, individually, party of the second part, WITNESSETH as follows:
*1393 Said second party owns a controlling interest in the stock of said corporation and would have the power to change the name of said company by appropriate corporate action so as not to include the name of said Charles P. Limbert and so as to thereafter prevent the use of said name by said company as a part of its corporate title or in connection with its trade-marks, and the said corporation is desirous of acquiring the right to use the name of said Charles P. Limbert personally as a part of its corporate title, and also as a part of or in connection with trade-marks, and of obtaining an agreement with the said Charles P. Limbert that so long as he continues to be the owner of a controlling interest in the stock of said company no action will be taken without the unanimous consent of all the stockholders changing said name so as to eliminate the name of said Charles P. Limbert therefrom, it being deemed that the right to use said name permanently is and will be of great value to said corporation.
The said Charles P. Limbert, *4226 ever since the said corporation was organized and commenced business, has been its manager upon whom the success or failure of said business has been and is almost wholly dependent, and the said corporation is also desirous of insuring the continuance of his services with and for the company for a definite term of years and to so arrange that neither his name nor his services and ability will be used in or devoted to any competing company or business. It is therefore hereby agreed between the parties as follows:
The said Charles P. Limbert does hereby give and grant to said corporation the permanent right to use his name in its corporate title and in or in connection with its trade-marks, and agrees that so long as he continues to own a controlling interest in the stock of said company no action shall be taken whereby the articles of association shall be so amended as to eliminate his name from the said corporate name, and agrees that so long as his personal name remains a part of said corporate name he will not give, or attempt to give, to any other competing concern the right to use his name in connection with their business, nor will he give his services or any part thereof to*4227 any competing business. He further agrees to continue in the management of said corporation for a period of ten (10) years from this date at the same annual salary which he is now receiving, and to devote his time, attention and ability to the business of the said corporation as heretofore during the said entire ten (10) year period.
In consideration of all of which the said party of the first part agrees to pay the said Charles P. Limbert the sum of Twenty-five thousand dollars ($25,000) in cash on request, and to issue to him Forty-five thousand dollars par value of full-paid non-assessable treasury stock of said corporation.
The contract was entered on petitioner's books at $70,000 under an account termed "Trade-marks, Contracts and Patterns." The $25,000 cash and the $45,000 par value of stock payments were made to Limbert who continued as the active head of petitioner's business until his death in 1922.
Between the years 1906 and 1911, the corporation made rapid strides in respect to its earnings. Its business and product were widely advertised and were developed in the furniture market so that it was one of the outstanding lines in the market. The growth of the business*4228 during this period, as well as subsequent thereto, is *1394 shown by a schedule of tangible net worth, sales, and profits reflected by the books as follows:
| Year | Tangible net worth | Sales | Profit |
| 1906 (Aug. 10) | $55,000.00 | $50,042.51 | $2,832.87 |
| 1907 (Jan. 1) | 57,832.87 | 132,987.62 | 9,201.49 |
| 1908 | 66,438.40 | 186,061.96 | 24,226.03 |
| 1909 | 90,345.74 | 263,786.74 | 33,287.77 |
| 1910 | 122,953.01 | 305,625.76 | 25,057.78 |
| 1911 | 148,167.00 | 346,298.11 | 35,647.02 |
| 1912 | 172,122.73 | 388,035.44 | 44,134.55 |
| 1913 | 216,257.28 | 416,970.35 | 39,330.86 |
| 1914 | $230,588.14 | $386,335.00 | $14,174.51 |
| 1915 | 244,762.65 | 345,240.35 | 1 7,337.25 |
| 1916 | 237,425.40 | 371,081.73 | 15,131.81 |
| 1917 | 246,557.21 | 503,240.89 | 25,179.12 |
| 1918 | 271,736.43 | 345,728.63 | 10,384.44 |
| 1919 | 274,027.27 | 669,821.76 | 114,826.15 |
| 1920 | 343,853.42 | 908,039.02 | 189,990.03 |
| 1921 | 509,731.29 | 697,937.76 | 113,915.62 |
The balance sheets of petitioner, as shown by its books, as of December 31, 1910, and December 31, 1911, were as follows:
| Dec. 31, 1910 | Dec. 31, 1911 | |
| ASSETS | ||
| Current assets: | ||
| Cash | $1,497.58 | $152.08 |
| Accounts receivable | 76,994.52 | 75,138.97 |
| Inventory | 112,233.26 | 100,687.27 |
| Total | 190,725.36 | 175,978.32 |
| Fixed assets: | ||
| Land | 5,500.00 | 15,500.00 |
| Buildings | 37,824.39 | 48,238.10 |
| Machinery and equipment | 32,159.37 | 45,256.29 |
| Furniture and fixtures | 5,022.12 | 7,226.86 |
| Trade-marks and patterns | 66,600.00 | |
| Total | 80,505.88 | 182,821.25 |
| Deferred charges to future operations | 2,016.26 | 2,586.36 |
| Total assets | 273,247.50 | 361,385.93 |
| LIABILITIES AND CAPITAL | ||
| Current: | ||
| Bills payable | 84,480.25 | 74,846.33 |
| Accounts payable | 20,600.25 | 24,416.87 |
| Total | 105,080.50 | 99,263.20 |
| Long term | 20,000.00 | 20,000.00 |
| Total liabilities | 125,080.50 | 119,263.20 |
| Capital: | ||
| Capital stock | 55,000.00 | 100,000.00 |
| Surplus | 93,167.00 | 142,122.73 |
| Total capital | 148,167.00 | 242,122.73 |
| Total liabilities and capital | 273,247.50 | 361,385.93 |
*4229 The business had about 450 customers when incorporated. This number had increased to almost 1,000 customers by 1911. The successful growth of the business during the period beginning with its organization and continuing through the years in question was largely due to the efforts and ability of Limbert. The value of the contract with Kimbert was at least $70,000 when acquired in 1911.
*1395 Petitioner's stock has never been listed upon any stock exchange. No stock has ever been sold for less than par. The par value of stock outstanding was $300,000 on March 3, 1917, and January 1, 1919, and $460,000 on January 1, of 1921, and 1922.
Between the years 1904 and 1914, petitioner expended the following amounts for advertising under photo and catalogue expenses:
| Year | Advertising | Photo and catalogue |
| 1909 | $12,365.75 | $6,177.44 |
| 1910 | 10,512.34 | 3,369.97 |
| 1911 | 13,661.47 | 4,900.24 |
| 1912 | $11,948.50 | $6,738.64 |
| 1913 | 10,671.78 | 9,179.56 |
| 1914 | 12,326.98 | 2,446.75 |
Between the years 1909 and 1914, petitioner advertised in a considerable number of national advertising mediums.
The respondent, in computing the tax of the petitioner for the years 1919*4230 and 1921, did not allow any invested capital on account of the contract dated October 17, 1911, between the petitioner and Limbert.
At the hearing respondent refused to obey a subpoena duces tecum, served on respondent June 29, 1927, calling for the production of certain data respecting proper comparative corporations and other details for the purpose of establishing petitioner's right to the relief claimed before the Board.
The income and profits-tax return of the petitioner for the year 1919 was filed on or before March 15, 1920, with the collector of internal revenue at Detroit, Mich. The notice of final determination of a deficiency required of the respondent under section 274(a) of the Revenue Act of 1924 was mailed to petitioner on August 14, 1925, more than five years after the return for 1919 was filed.
OPINION.
SIEFKIN: The principal question presented is the value of the contract for the services and the use of the name of Charles P. Limbert acquired by petitioner in 1911 in return for $45,000 par value of its stock and $25,000 in cash. The petitioner contends that the value of this contract should be allowed as invested capital.
Section 301 of the Revenue*4231 Act of 1918 provides for an excess-profits tax, based upon the relation of the net income to the invested capital.
Sections 311 and 312 allow credits based upon the invested capital.
Section 326 provides:
(a) That as used in this title the term "invested capital" for any year means * * *:
* * *
(4) *1396 Intangible property bona fide paid in for stock or shares prior to March 3, 1917, in an amount not exceeding (a) the actual cash value of such property at the time paid in, (b) the par value of the stock or shares issued therefor, or (c) in the aggregate 25 per centum of the par value of the total stock or shares of the corporation outstanding on March 3, 1917, whichever is lowest.
Section 325 states:
The term "intangible property" means patents, copyrights, secret processes and formulae, good will, trade-marks, trade-brands, franchises, and other like property;
The term "tangible property" means stocks, bonds, notes, and other evidences of indebtedness, bills and accounts receivable, leaseholds, and other property other than intangible property. (Italics supplied.)
The Revenue Act of 1921 has similar provisions.
It will be noted that each*4232 of these acts includes in "invested capital" certain specified intangible properties, such as patents, copyrights, secret processes and formulae, good will, trade-marks, trade-brands and franchises, and other like property.
The question arises then as to what property may be included as invested capital under these general terms. A perusal of the legislative history fails to disclose any amplification upon the subject, the discussion being confined more or less to the manner of determining the value of intangibles.
Contracts, generally speaking, are of an intangible nature, and are often quite valuable. It would seem that the intention of Congress was to allow as invested capital any valuable tangible or intangible property which was bona fide acquired for stock or shares, subject to certain limitations as to value allowed.
We have heretofore held that contracts may be included in invested capital.
In , we held that license agreements authorizing the licensees to make and use certain patented machines for refining ores, acquired for stock by a corporation, are intangible property for invested capital*4233 purposes and as such are subjec to the limitations on intangibles contained in the Revenue Act of 1917.
In , a contract to furnish electric energy to be produced in the future, acquired by the issue of stock, was held to be intangible property where the taxpayer had the right, but only in case of breach of contract, to the use of the tangible property - generators and other machinery. The value of the contract was allowed as invested capital subject to the statutory limitation on intangibles.
*1397 We have also held that money paid, in addition to regular salaries, to secure services, may be included in invested capital. In the , we stated:
The petitioner also contends that the amount of $100,000 which it paid to its general manager and plant superintendent in addition to stated salaries shall be included in its statutory invested capital. To sustain its contention on this point it asserts that these men performed services in the completion of its manufacturing plant analogous to the duties and functions of designing and supervising architects*4234 or engineers, and that the result of such services is reflected in its capital assets. * * * It was largely through their supervision and direction that the plant was made ready for production. To secure the services of these men for the purposes here indicated, the petitioner paid each of them the amount of $50,000, which was in addition to remuneration for services connected with the operation of the enterprise. We are of the opinion that these payments were capital expenditures and should be included in the computation of the petitioner's invested capital for profits-tax purposes in each of the taxable years.
In the decision of the case of , Mr. Justice Pitney of the Supreme Court of the United States defines the words "to invest" as follows:
When speaking of the capital of a business corporation or partnership, such as the act deals with, "to invest" imports a laying out of money, or money's worth, either by an individual in acquiring an interest in the concern with a view to obtaining income or profit from the conduct of its business, or by the concern itself in acquiring something of permanent use*4235 in the business; in either case involving a conversion of wealth from one form into another suitable for employment in the making of the hoped-for gains.
In this proceeding we must decide whether a contract for which the petitioner paid $25,000 cash and issued $45,000 par value of stock in the year 1911 should be included as invested capital. It is shown that up to the time of the acquisition of the contract the success of the business was due to the personality, ability, and energy of Limbert, and had Limbert changed the name of the company and left the business, as he had an unquestioned right to do, petitioner would have had to begin over again. The contract in question was entered into between Limbert and petitioner, and Limbert gave the petitioner the permanent right to use his name in its corporate title and in or in connection with its trade-marks, and agreed that he would not give the right to use his name in the same manner to any other concern, nor would he give his services or any part thereof to any competing business. He further agreed to manage the business of petitioner for a period of 10 years.
A part of the consideration given by Limbert was of a permanent*4236 nature and part was for his services for a period of years.
It is not necessary to determine whether the contract was intangible or tangible property, since the amount claimed is less than *1398 the maximum for intangibles as invested capital as provided by section 326(a)(4) of the Revenue Acts of 1918 and 1921, but we find that this contract had a value of $70,000, and since the asset is of a permanent nature and was bona fide obtained for cash and shares of stock in petitioner's business, it should be included as invested capital for that amount for each of the years in controversy.
We are, however, unable to see that the contract value may be recovered by exhaustion deductions as claimed by petitioner. The contract granted petitioner the permanent exclusive right to use Limbert's name. This feature of the contract was not, in any sense, an expiring asset, and therefore, in so far as the contract derived value from this provision, it is not depreciable. No attempt to allocate the total value between the two features of the contract has been made. Accordingly, the deductions claimed therefor must be denied.
The claim for special assessment being made in the alternative*4237 need not be considered in view of our valuation of the contract.
From our findings of fact it appears that more than five years elapsed between the filing of the return for the year 1919 and the mailing of the deficiency notice and that the proposed deficiency is barred by the statute of limitations. .
Reviewed by the Board.
Judgment will be entered on 15 days' notice, under Rule 50.
MARQUETTE, SMITH, and ARUNDELL dissent.
MURDOCK, dissenting: I dissent from the foregoing opinion first, for the reason that the value of the contract represented by the right to the continued use of Limbert's name was not such an asset as could form the basis for any amount of invested capital because of earned surplus or otherwise.
Furthermore, the Board has found that the contract with Limbert had a value of $70,000, that it was an asset of a permanent nature, and that it should be included in invested capital at the amount of $70,000 for each of the years in controversy. To hold that the contract in question was of permanent value overlooks the fact that a considerable portion of the value of the contract represented advance*4238 salary to Limbert for 10 years and that as those 10 years passed, this value exhausted.
The opinion holds that it is unnecessary to decide whether the contract was tangible or intangible property, since the amount to be included in invested capital is less than the maximum for intangibles, as provided by section 326(a) of the Revenue Acts of 1918 and 1921. *1399 Yet, it appears that the consideration paid by the petitioner for the contract in question included $25,000 in cash and in regard to that portion of the value of the contract so purchased, the above mentioned sections of the Revenue Acts would not be applicable.
STERNHAGEN concurs in this dissent.
Footnotes
1. Loss. ↩