*1808 1. Petitioner's contention, that its income was overstated in the amount of $15,000, denied.
2. Petitioner acquired a mixture of tangible and intangible assets for its capital stock and cash. Held, that for the purpose of determining the amount of intangibles acquired for stock to be used in the application of the 25 per cent limitation on intangibles, the cash, in the absence of evidence to the contrary, should be considered as having been paid for the tangibles. Petitioner's contention, that the cash should be allocated between the two classes of assets in proportion to their cash value when acquired, denied.
3. Special assessment allowed.
*862 This proceeding is for the redetermination of deficiencies in income and profits taxes for the eleven-month period ending December 31, *863 1920, and the calendar year 1921 in the amounts of $5,657.04 and $5,895.65, respectively.
There are three issues involved, namely, (1) whether petitioner's income for the period in 1920 is overstated in an amount of $15,000; (2) whether a part*1809 of petitioner's intangible assets should be considered as having been acquired for cash instead of capital stock; and (3) whether petitioner's excess-profits taxes should have been determined in accordance with sections 327 and 328 of the Revenue Acts of 1918 and 1921.
Upon motion granted, the hearing in the first instance with respect to the last issue was confined to the issues defined in subdivisions (a) and (b) of Rule 62 of the Board's rules of practice.
FINDINGS OF FACT.
Petitioner was incorporated under the laws of the State of Indiana on January 26, 1920, for the purpose of taking over the publication of The Evansville Courier, a daily and Sunday newspaper then being published at Evansville, Ind.
The publication of The Evansville Courier commenced about the year 1845. In 1903 the business was incorporated under the corporate name of The Evansville Courier Publishing Company, which corporation continued to publish the paper until the latter part of January, 1920.
On January 31, 1920, The Evansville Courier Publishing Company sold to one Henry W. Marshall, an individual, the following described property and assets:
The daily and Sunday newspaper known*1810 as The Evansville Courier, together with its good will and circulation, the Associated Press membership standing in the name of Henry C. Murphy, and all franchises belonging to said newspaper, together with the newspaper publishing plant, property, machinery and equipment of every kind and description used in the publishing of said newspaper;
Also all newsprint paper and supplies, furniture and fixtures, together with all circulation accounts and advertising accounts receivable which remain unpaid after the 31st day of January, 1920;
Also all the transferor's assignable rights and interest in its present contract with the International Paper Company for newsprint paper supply for the year 1920.
The consideration paid for such property and assets by Marshall was as follows:
(1) Cash $250,000;
(2) 265 shares preferred stock (par value $100 per share) of the Public Utilities Company of Evansville;
(3) 2,750 shares preferred stock (par value $100 per share) of petitioner to be issued;
*864 (4) Assumption of all current accounts payable; and
(5) Assumption of one-half of all Federal income taxes thereafter assessed against the seller on its newspaper earnings*1811 for the month of January, 1920.
In addition to the above list of assets sold and consideration paid therefor the bill of sale from the Evansville Courier Publishing Company to Marshall contained the following provisions:
In addition to the transfer, conveyance and delivery of the foregoing property and assets, the transferor, said THE EVANSVILLE COURIER PUBLISHING COMPANY, herewith pays to the transferee the sum of Fifteen Thousand Dollars ($15,000.00) in cash, receipt of which is hereby acknowledged through the acceptance of this instrument, to cover the unearned part of prepaid newspaper subscriptions.
On the same date, namely, January 31, 1920, Marshall sold the same identical property and assets described above to the petitioner herein for the following consideration as stated in the bill of sale from Marshall to the petitioner:
(1) Cash $99,600;
(2) 3,000 shares preferred stock (par value $100 per share) of petitioner;
(3) 2,000 shares common stock (par value $100 per share) of petitioner;
(4) Assumption of all current accounts payable; and
(5) Assumption of one-half of all Federal income taxes thereafter assessed against The Evansville Courier Publishing Company*1812 on its newspaper earnings for the month of January, 1920.
In addition to the above list of assets sold and consideration paid therefor, the bill of sale from Marshall to the petitioner contained the following provision:
In addition to the transfer, conveyance and delivery of the foregoing property and assets, the transferor, said HENRY W. MARSHALL, hereby pays to the transferee the sum of FIFTEEN THOUSAND DOLLARS ($15,000) in cash, receipt of which is hereby acknowledged through the acceptance of this instrument to cover the unearned part of prepaid newspaper subscriptions.
The actual amount of subscriptions paid for in advance to the Evansville Courier Publishing Company on January 31, 1920, was $26,326.88. Petitioner was under obligation to either furnish its subscribers with the paper for which they had paid their subscriptions in advance or to refund such prepaid subscriptions. This obligation was a part of the current liabilities assumed by petitioner.
The petitioner, in order to secure the cash with which to pay Marshall, borrowed $100,000 from the banks of Evansville on January 30, 1920.
In addition to obtaining the above mentioned loan of $100,000 and the purchasing*1813 of the foregoing properties and assets from Marshall, petitioner issued four shares of its common stock for $400 cash.
*865 The journal entries recording all of the above mentioned transactions were recorded on petitioner's books between the dates of January 30, 1920, and February 3, 1920, as follows:
| Items | Debits | Credits |
| Cash | $100,000.00 | |
| To Bills Payable | $100,000.00 | |
| Plant and Equipment | 105,539.33 | |
| Office Furniture and Fixtures | 8,644.06 | |
| Material and Supplies | 10,648.73 | |
| Circulation, Associated Press Membership and Good Will | 474,767.88 | |
| To Cash | 99,600.00 | |
| To Preferred Stock | 300,000.00 | |
| To Common Stock | 200,000.00 | |
| Accounts Receivable | 33,072.73 | |
| To Accounts Payable | 8,293.88 | |
| To Unearned Subscriptions | 24,778.85 | |
| Cash | 15,000.00 | |
| To Unearned Subscriptions | 15,000.00 | |
| Cash | 400.00 | |
| To Common Stock | 400.00 | |
| Total Debits and Credits | 748,072.73 | 748,072.73 |
Petitioner's opening balance sheet taken from its books as of the day it commenced business, and before any adjustments were made thereto, was as follows:
| Assets | Liabilities | ||
| Cash | $15,800.00 | Preferred stock | $300,000.00 |
| Plant and equipment | 105,539.33 | Common stock | 200,400.00 |
| Office furniture and fixtures | 8,644.06 | Bills payable | 100,000.00 |
| Material and supplies | 10,648.73 | Accounts payable | 8,293.88 |
| Circulation, Associated Press membership, and good will | 474,767.88 | ||
| Accounts receivable | 33,072.73 | ||
| Total | 648,472.73 | Total | 648,472.73 |
*1814 Prior to the respondent's determination the parties herein agreed upon all of the values set out in the above balance sheet except the intangible asset account (circulation, Associated Press membership and good will) and the unearned subscriptions account. With respect to these items the parties agreed, and the respondent so determined, that the unearned subscriptions account on the opening balance sheet should be $26,326.88 instead of $39,778.85, and that the difference, or $13,451.97, should be deducted from the intangible asset account. The respondent further determined that the intangible asset account included a prepaid expense item of $11,326.88 which was deducted from the intangible asset account and set up on the balance sheet as a separate asset. The respondent, in determining the deficiencies herein, thus determined petitioner's opening balance sheet as of the day it commenced business to be as follows:
| Assets | Liabilities | ||
| Cash | $15,800.00 | Preferred stock | $300,000.00 |
| Plant and equipment | 105,539.33 | Common stock | 200,400.00 |
| Office furniture and fixtures | 8,644.06 | Bills payable | 100,000.00 |
| Material and supplies | 10,648.73 | Accounts payable | 8,293.88 |
| Circulation, Associated Press | |||
| membership, and good will | 449,989.03 | ||
| Accounts receivable | 33,072.73 | ||
| Prepaid expense | 11,326.88 | ||
| Total | 635,020.76 | Total | 635,020.76 |
*1815 *866 Petitioner has taken no exception in its petition or at any other place in the record to the values set out in the above opening balance sheet as determined by the respondent.
Beginning on February 28, 1920, and at the close of each month thereafter for the remainder of the year 1920, petitioner transferred on its books one-eleventh of the unearned subscriptions account of $24,778.85 to a subscriptions earned account and one-eleventh of the unearned subscriptions account of $15,000 to a city circulation earnings account. On December 31, 1920, petitioner transferred on its books the subscriptions earned account of $24,778.85 direct to the undivided profits account as representing a return of capital invested. On December 31, 1920, petitioner transferred on its books the city circulation earnings account of $15,000 to the profit and loss account as representing a part of its income for the 11-month period ending December 31, 1920. In its return petitioner reported the $15,000 as income, but did not report the $24,778.85 as income. The respondent in his determination made no change in petitioner's net income as reported as far as these two items are concerned.
*1816 The gross income, deductions and the resulting net income as reported by petitioner on its income and profits-tax return for the 11-month period ending December 31, 1920, and as determined by the respondent are as follows:
| Gross income | Petitioner's tax return | Respondent's determination |
| Advertising earnings | $300,084.43 | $300,084.43 |
| City circulation earnings | 15,000.00 | 15,000.00 |
| Other circulation earnings (exclusive of the $24,778.85) | 103,313.86 | 103,313.86 |
| Miscellaneous income | 3,149.65 | 3,149.65 |
| Total | 421,547.94 | 421,547.94 |
| DEDUCTIONS | ||
| Business department expense | 14,877.74 | 14,877.74 |
| News department expense | 49,160.07 | 49,160.07 |
| Advertising department expense | 17,313.12 | 17,313.12 |
| Circulation department expense | 43,236.09 | 43,236.09 |
| Composing department expense | 55,418.28 | 55,418.28 |
| Press department expense | 5,774.25 | 5,774.25 |
| Stero department expense | 5,602.62 | 5,602.62 |
| General expense 1 | 14,899.47 | 14,769.78 |
| Department supplies | 4,984.90 | 4,984.90 |
| Paper | 130,891.65 | 130,891.65 |
| Ink | $2,182.68 | $2,182.68 |
| Comic supplement | 5,789.02 | 5,789.02 |
| Insurance | 511.88 | 511.88 |
| Interest | 5,295.20 | 5,295.20 |
| Taxes | 1,878.29 | 1,878.29 |
| Organization expense 1 | 956.40 | None. |
| Local advertising adjustments | 1,564.46 | 1,564.46 |
| Foreign advertising adjustments | 1,818.28 | 1,818.28 |
| Bad debts | 3,276.26 | 3,276.26 |
| Depreciation 1 | 11,261.97 | 10,659.11 |
| Loss on print paper | 7,354.20 | 7,354.20 |
| Total | 384.040.83 | 382,357.88 |
| Net income (gross income less deductions) | 37,501.11 | 39,190.06 |
*867 The respondent determined petitioner's invested capital for the 11-month period ending December 31, 1920, to be $160,885.06 as follows:
| Net tangible assets | $50,010.97 | |
| Intangible assets | 449,989.03 | |
| Stock issued for cash | 400.00 | |
| Capital stock issued | 500,400.00 | |
| Less intangible asset adjustment: | ||
| Intangibles per balance sheet | $449,989.03 | |
| 25 per cent of capital stock | 125,100.00 | |
| Intangibles excluded | 324,889.03 | |
| Invested capital for full year | 175,510.97 | |
| Invested capital for 11 months | 160,885.06 |
The respondent, in determining petitioner's invested capital for the calendar year 1921, also determined that the intangible assets in the amount of $449,989.03 acquired from Marshall were acquired for stock and that in accordance with section 326(a)(5) of the Revenue Act of 1921, only $125,100 of such assets could be included in petitioner's invested capital.
During the 11-month period ending December 31, 1920, petitioner paid and deducted on its income and profits-tax return for that period officers' salaries in the amount of $100.
The respondent determined petitioner's excess-profits tax for the periods*1818 before us under section 301 of the Revenue Acts of 1918 and 1921, respectively.
OPINION.
LOVE: The first issue is whether petitioner's income for the 11-month period ending December 31, 1920, is overstated in the amount of $15,000.
*868 Petitioner contends that the provision in its bill of sale from Marshall wherein it is recited that Marshall "hereby pays" to petitioner $15,000 in cash "to cover the unearned part of prepaid newspaper subscriptions" clearly shows that the $15,000 was nothing more than a reduction in the purchase price of the property and assets from Marshall, and that both petitioner and respondent were in error in treating the $15,000 as income. Petitioner, therefore, prays that its net income as determined by the respondent for the period in 1920 be reduced by the amount of $15,000.
The respondent's position is that, while it may be true that when petitioner paid $99,600 in cash as part consideration for the property and assets and received as a part of such property and assets $15,000 in cash, the net result was the same as if it had only paid $84,600 in cash, yet it assumed a liability to either furnish a newspaper to those subscribers who had*1819 paid their subscriptions in advance or to refund their prepaid subscriptions, and that the liquidation of such liability was not deductible as a business expense. In other words, the respondent contends that if the gross income as reported by petitioner and as determined by him is to be reduced by $15,000, then an equal amount of expenses should be disallowed, in which event the net income would and should remain the same as determined in the deficiency notice.
We are of the opinion that the contention of the respondent upon this point is sound and should be sustained. In its return petitioner claims the deduction from gross income of all of its ordinary and necessary operation expenses. In the determination of the deficiency the respondent has not disallowed any portion of the amount which the petitioner may have paid in fulfilling its liability to the subscribers who had paid their subscriptions to the former owner of the paper. The former owner turned over to petitioner $15,000 of the subscriptions which it had received, an amount which presumably was to recompense the petitioner for assuming the obligation of the predecessor owner with respect to the prepaid subscriptions. *1820 We are of the opinion that the $15,000 represents income to the petitioner to the same extent as though the subscribers themselves had paid that amount of money to the petitioner, and that if that $15,000 was to be excluded from the gross income of petitioner, an equal amount should be disallowed from the deductions which had been allowed petitioner in the computation of the deficiency. In our opinion the contentions of petitioner upon this point are without merit and they are not sustained.
The second issue is whether, at the time of organization, a part of petitioner's intangible assets (circulation, Associated Press membership and good will) should be considered as having been acquired *869 for cash instead of capital stock. The facts are that petitioner acquired a mixture of tangible ($169,231.73) and intangible ($449,989.03) assets (total $619,220.76) in consideration for the following:
| Capital stock | $500,000.00 |
| Cash | 84,600.00 |
| Liabilities assumed | 34,620.76 |
| Total | 619,220.76 |
Petitioner concedes that the assumed liabilities are to be charged against the tangible assets as is provided for in article 835 of respondent's Regulations 45 and 62. See*1821 also , wherein we held that, where a mixture of tangible ($1,505,684.83) and intangible ($2,202,415.20) assets were acquired for $2,800,000 par value of bonds and $5,600,000 par value of stock, "the bonds were issued first for tangibles; that the bonds in excess of the tangibles were issued for intangibles, and that the remainder of the intangibles were acquired for stock."
The respondent, in his determination, also treated the cash as if it had been paid for the tangibles. It is at this point that petitioner contends the respondent erred. Petitioner contends that there is no more justification for saying that the cash was paid for the tangibles than to say it was paid for the intangibles. In fact, petitioner argues very strongly that in a newspaper business the intangibles are considered as more important to the success of the enterprise than are the tangibles, and that, if anything, the cash ought to be considered as having been paid for the intangibles rather than the tangibles. But petitioner is not pressing its contention that far. Its position here is that, in the absence of evidence to the contrary, the cash*1822 and capital stock should be allocated to the tangible and intangible assets according to their cash value at the time paid in, which would be as follows:
| Assets | Amount | Acquired for cash | Acquired for stock |
| Tangible | $134,610.97 | $19,480.14 | $115,130.83 |
| Intangible | 449,989.03 | 65,119.86 | 384,869.17 |
| Total | 584,600.00 | 84,600.00 | 500,000.00 |
The contention advanced by petitioner finds its root in the limitations Congress placed on the amount of intangible assets acquired for stock that could be included in a taxpayer's statutory invested capital. See section 326(a)(4) and (5) of the Revenue Acts of 1918 and 1921. Were it not for these limitations it would make no difference whether the $84,600 was paid for tangibles or intangibles, *870 for the reason that the $84,600 was borrowed capital, and, as such, was specifically excluded from invested capital by section 326(b) of the Revenue Acts of 1918 and 1921. To illustrate, if the $84,600 were paid for tangible assets, it would follow that the $500,000 of capital stock was issued for $50,010.97 of tangibles and $449,989.03 of intangibles. Under section 326(a)(5), supra, only $125,100 of the intangibles*1823 may be included in the statutory invested capital, which, with the $50,010.97 of tangibles and the $400 of stock issued for cash, makes up the $175,510.97 invested capital determined by the respondent for the full year. On the other hand, if $19,480.14 of the $84,600 were paid for tangibles and $65,119.86 for intangibles, it would follow that the $500,000 of capital stock was issued for $115,130.83 of tangibles and $384,869.17 of intangibles, and, since the latter amount was still in excess of the limitation, petitioner's statutory invested capital would be $65,119.86 larger than that determined by the respondent, or $240,630.83, computed as follows:
| Net tangible assets | $115,130.83 | |
| Intangible assets | 384,869.17 | |
| Stock issued for cash | 400.00 | |
| Capital stock issued | 500,400.00 | |
| Less adjustment for intangibles: | ||
| Intangibles for stock | $384,869.17 | |
| 25% of capital stock | 125,100.00 | |
| Intangibles excluded | 259,769.17 | |
| Invested capital for full year | 240,630.83 |
In support of its contention, petitioner cites and relies upon our decision in *1824 . In that case the facts were that the taxpayer acquired tangible and intangible assets in exchange for stock and the assumption of certain liabilities. We there held that the value of the tangibles should be reduced by the amount of the liabilities; that the capital stock should be applied against the remaining tangibles and intangibles, according to the cash value of each class of assets at the date of acquisition; that the excess of the cash value of tangibles over the par value of the capital stock allocated to the tangibles constituted paid-in surplus; and that the intangibles so paid in for stock should be included in invested capital subject to the 25 per cent limitation contained in the statute. The principle there established has been applied in ; ; ; ; ; and *1825 . Petitioner argues in its brief that the sole difference between its contention in the instant case and the principle established by the Board in the St.*871 Louis Screw Co. case is the fact that petitioner paid cash in addition to issuing stock. It overlooks, however, the fact that the liabilities assumed in the St. Louis Screw Co. case were applied first against the tangible assets.
The respondent in his brief relies upon and quotes at length from our decision in As stated above, the taxpayer in the latter case issued its own stock and bonds for a mixture of tangible and intangible assets. The only difference in the instant case is that in place of issuing stock and bonds, petitioner issued stock and paid cash which it had previously borrowed. If it had given its note to Marshall instead of to the banks for the sum paid to Marshall, the two cases would be identical. The distinction between the two cases is not one that requires the application of a different rule. Furthermore, the facts in the instant case are, for all practical purposes, parallel*1826 with the facts in . The petitioner in that case acquired a newspaper business from a partnership of two individuals. In doing so it acquired a mixture of tangible and intangible assets and in exchange therefor issued $15,000 of stock to one partner and paid $15,000 in cash to the other partner. Petitioner there contended that since it had actually paid $15,000 in cash to one of the partners, at least one-half of its intangibles should be considered as having been acquired for cash. We denied the contention and held that the cash should be treated as having been paid for the tangibles. The same rule should be applied in the instant case. We, therefore, approve the respondent's determination as to this issue.
The third issue is whether petitioner comes within the provisions of sections 327 and 328 of the Revenue Acts of 1918 and 1921. We have found that petitioner had a commercial invested capital of $500,400, consisting of net tangible assets of $50,410.97, and intangibles of $449,989.03, and that by the proper application of section 326(a)(5), supra, only $125,100 of such intangible assets could be included*1827 in its statutory invested capital. A taxpayer is not entitled to have its profits taxes computed under the special assessment provisions of the statute because a part of its commercial invested capital is not recognized as a part of its statutory invested capital. . The exclusion must be such as to create an abnormal condition. ; ; ; ; ; and . In the instant case the assets excluded were the most substantial part of petitioner's capital and the principal *872 contributing factor in the production of taxable income, which, in our opinion, brings it within the scope of the special assessment provisions of the statute.
Further proceedings will be had under Rule 62(c).
Footnotes
1. Indicates changes. ↩