*2608 The petitioner is entitled to special assessment for the years 1918 and 1919 under sections 327 and 328 of the Revenue Act of 1918.
*310 This proceeding is for the redetermination of deficiencies in income and profits taxes asserted by the respondent in the amounts of $21,156.05 for the year 1918 and $910.27 for the year 1919. The petitioner alleges that, in computing its invested capital for the years 1918 and 1919, the respondent erred in using as the income and excess-profits tax of the predecessor partnership, Farnsworth, Hoyt & Co., for the year 1917, the amount of $397,398.69 instead of the amount of $277,398.69, which was the tax finally determined by the respondent to be due from said partnership for the year 1917. The petitioner also alleges that it is entitled to have its profits tax for the years 1918 and 1919 computed under section 328 of the Revenue Act of 1918.
FINDINGS OF FACT.
The petitioner is a corporation organized under the laws of Massachusetts on or about December 31, 1917, with a capital*2609 stock of $1,100,000, divided into 10,000 shares of preferred stock and 1,000 shares of common stock of the par value of $100 each. Both classes of stock have voting rights.
For many years prior to December 31, 1917, there was in existence a partnership engaged in the shoe goods business of Boston, Mass., under the firm name and style of Farnsworth, Hoyt & Co. The general partners in 1917 were Charles C. Hoyt and Robert P. Gay, who had been connected with the business since about 1885. James D. Farnsworth had a special interest in the firm in the amount of $25,000.
The partnership was the original shoe goods concern in the United States and it held a commanding position in that business. A gradual increasing business had been built up by a long course of fair dealing, by the introduction of new and desirable improvements in the industry, and by advertising and pushing trade-marked lines of goods. It introduced into the shoe industry the use of celluloid eyelets, which were superior to and replaced the previously used brass eyelets, and heavier and more serviceable shoe linings, which was an important improvement. In connection with its linings the partnership registered*2610 and used the valuable trade-mark "Wear Proof," signifying that the lining sold under that name was more durable than ordinary lining. The firm also introduced to the shoe industry the valuable trade-marked "Rushur" leather, which was a lining filled with paraffine wax and of demonstrated merit. The trade-marks "Wear Proof" and "Rushur" were well known in the shoe industry and constituted an important part of the partnership business. The partnership also used the established trade-name product known as "Red-line-in," a quality lining for shoes.
In the year 1913 the partnership of Farnsworth, Hoyt & Co. started the publication of a magazine intended largely to advertise its special *311 linings "Wear Proof" and "Rushur," and other goods sold by it. It was the practice of the partnership to send these magazines to practically every shoe manufacturer in the United States and to a large percentage of the shoe retailers and jobbers. The publication necessitated the employment of an editor and two or three assistants. The cost of getting out the magazine, except the salaries and wages of the persons connected with that department, was charged to advertising. The partnership*2611 spent the following amounts for advertising:
| 1913 | $5,434.24 |
| 1914 | 8,880.82 |
| 1915 | 13,285.02 |
| 1916 | 10,175.39 |
| 1917 | 13,728.45 |
In the year 1917 about 800 of the 1,200 or 1,500 shoe manufacturers in the United States were customers of Farnsworth, Hoyt & Co., and many of such manufacturers had been customers from 10 to 30 years. The firm had a nucleus of from 200 to 250 shoe manufacturers who bought from it practically all the goods used by them of the kind sold by the partnership.
The net value of the tangible assets of the partnership of Farnsworth, Hoyt & Co. for the years 1913 to 1917, inclusive, as shown by its books, was as follows:
| Jan. 1, 1913 | $390,080.28 |
| Dec. 31, 1913 | 450,531.95 |
| Dec. 31, 1914 | 445,845.75 |
| Dec. 31, 1915 | $521,392.99 |
| Dec. 31, 1916 | 832,332.43 |
| Dec. 31, 1917 | 1,195,152.68 |
The respondent determined, in computing the prewar invested capital of the partnership, that its net worth as of January 1. 1913, was understated on its books by the amount of $1,034.59, and that its net worth as of December 31, 1916, was understated by the amount of $13,768.38. These understatements of net worth were due to the fact that machinery*2612 and equipment, and furniture and fixtures, were understated in like amounts.
The net earnings of the partnership of Farnsworth, Hoyt & Co. for the years 1913 to 1917, inclusive, as shown by the books of the partnership, were as follows:
| 1913 | $112,971.32 |
| 1914 | 55,303.71 |
| 1915 | 111,046.55 |
| 1916 | 368,731.40 |
| 1917 | 411,915.68 |
In computing the book income for 1917 the partnership deducted $55,000 for salaries for Charles C. Hoyt and Robert P. Gay, and tax reserves of $390,466.96, but no corresponding deductions were made in prior years.
*312 For the year 1917 the partnership of Farnsworth, Hoyt & Co. filed an income and profits-tax return and showed profits tax due in the amount of $381,511.85, which was paid in full by the petitioner herein in the year 1918. In the year 1923 the respondent made an additional assessment of 1917 partnership excess-profits tax in the amount of $15,886.84, which was likewise paid by the petitioner. In the year 1924 the respondent determined that the net taxable income of the partnership for 1917, after allowing a deduction in the amount of $255,000 for salaries paid to Charles C. Hoyt and Robert P. Gay, was $633,551.31; that*2613 the partnership excess-profits tax for 1917 was $277,398.69, and that there had been an overpayment of the partnership excess-profits tax for that year in the amount of $120,000. Of the amount of said overpayment, $62,788.95 was, with the consent of the petitioner, credited to additional income taxes assessed against Charles C. Hoyt and Robert P. Gay as a result of the adjustments just mentioned, and the remainder, $57,211.05, was refunded to the petitioner.
On December 31, 1917, the good will of the partnership of Farnsworth, Hoyt & Co. had a fair market value of at least $1,000,000.
On December 31, 1917, the petitioner purchased all of the assets, including good will, patents, trade-names and trade-marks, of the partnership of Farnsworth, Hoyt & Co., subject to its liabilities, and issued to the partnership in exchange for said assets, 10,000 shares of the petitioner's preferred stock of the par value of $100 each, and its promissory notes in the amount of $220,152.68. The petitioner's common stock was sold for cash, $47,000 par thereof being purchased by Charles C. Hoyt and Robert P. Gay, members of the predecessor partnership, and $53,000 par value by employees of the company.
*2614 The closing balance sheet of the partnership and the opening balance sheet of the petitioner were as follows:
| Partnership books | Corporation books | |
| Dec. 31, 1917 | Jan. 1, 1918 | |
| ASSETS | ||
| Cash | $105,310.65 | $205,310.65 |
| Merchandise inventory | 1,292,775.24 | 1,292,775.24 |
| Accounts receivable | 537,704.58 | 537,704.58 |
| Notes receivable | 4,359.32 | 4,359.32 |
| Liberty bonds | 36,266.00 | 36,266.00 |
| Prepaid items | 7,803.57 | 7,803.57 |
| Machinery and equipment | 27,326.30 | 25,000.00 |
| Supplies, Hope 1 and 2 | 2,326.30 | |
| Furniture and fixtures | 8,932.79 | 8,932.79 |
| Autos | 2,605.48 | 2,605.48 |
| Auto truck | 2,790.00 | 2,790.00 |
| Total assets | 2,025,873.93 | 2,125,873.93 |
| LIABILITIES | ||
| Accounts payable | 137,485.71 | 137,485.71 |
| Notes payable | 302,768.58 | 497.921.26 |
| Reserve for taxes | 390,466.96 | 390,466.96 |
| Net worth | 1,195,152.68 | |
| Capital stock | 1,100,000.00 | |
| Total liabilities | 2,025,873.93 | 2,125,873.93 |
*313 The gross sales, less discounts, of the partnership for 1917 were $5,553,974.49. The gross sales, less discounts, of the petitioner for the years 1918 and 1919, were $7,038,198.21 and $7,070,960.68, respectively.
The respondent, upon audit of the petitioner's income*2615 and profits-tax returns for the years 1918 and 1919, did not include in invested capital any amount on account of good will acquired by the petitioner from the partnership of Farnsworth, Hoyt & Co., reduced invested capital in each year by the amount of $217,752.71, which represented income and profits taxes in the amount of $397,398.69 originally assessed against the partnership and prorated to the due dates thereof, and refused to compute the petitioner's tax liability under sections 327 and 328 of the Revenue Act of 1918.
OPINION.
MARQUETTE: The pleadings in this case raise two issues, namely, is the petitioner entitled to have its profits tax for 1918 and 1919 computed under section 328 of the Revenue Act of 1918 and, did the respondent err in adjusting the petitioner's invested capital for the fiscal years involved on account of the 1917 taxes of the partnership of Farnsworth, Hoyt & Co.? If the first issue is resolved in favor of the petitioner, decision on the second one will not be necessary.
The evidence herein establishes that on December 31, 1917, the petitioner in exchange for $1,000,000 par value of its preferred stock and in the amount of $220,152.68, acquired*2616 all of the assets, including good will, of the partnership of Farnsworth, Hoyt & Co., and that the good will so acquired had a fair market value of at least $1,000,000. This good will had been built up by the partnership over a period of about 60 years, but the value thereof did not appear in the partnership assets as shown by its books, and was not included in its invested capital, and because of the provisions of section 331 of the Revenue Act of 1918, it can not be included in the statutory invested capital of the petitioner. We are therefore confronted with the same situation found in , and , wherein we held that the petitioners were entitled to special assessment. In the Whitman case we said:
These intangible assets which the petitioner had acquired from Whitman gave it a volume of business and a reputation which had been built up over a period of many years. The petitioner was a newly organized corporation with no business and no good will of its own. When it acquired the tradenames, trade-marks and good will of Whitman, it acquired a business with*2617 annual sales of over $10,000,000 in each of the several past years. This business was first established by Whitman under his own name in 1874. The *314 testimony is that at the time petitioner took over this business, Whitman had built up one of the finest white line goods in the country. The evidence concerning the volume of sales and the profits of the predecessor partnership and predecessor corporation establishes that the business and profits were no temporary matter, but firmly established, and this is confirmed in the subsequent operations of the petitioner. It was these intangible assets which were the principal cause of the large income which petitioner enjoyed during the taxable years and on which the deficiencies in question are based. Because of its manner of organization these assets may not be included in the computation of its invested capital. We have held that a taxpayer does not fall within the provisions of sections 327 and 328 merely because assets are used in the business which may not be included in invested capital. *2618 . The exclusion must be such as to create an abnormal condition. Where, as here, the asset excluded is the most substantial part of its capital and is the principal contributing factor in the production of taxable income of the petitioner, it is our opinion that such an abnormality exists. ; ; ; ; ; .
There can be no doubt that the good will acquired by the petitioner from the partnership gave it a volume of business and a reputation that it otherwise would not have had, and that a material part of its earnings in 1918 and 1919 was due to that good will. We are of opinion that the cases cited are controlling and decisive here, and we accordingly hold that in 1918 and 1919 an abnormal condition existed affecting the petitioner's income and invested capital, and that it is entitled to the benefits of section*2619 328 of the Revenue Act of 1918.
Reviewed by the Board.
Judgment will be entered under Rule 62(c).