*2392 SPECIAL ASSESSMENT. - The business carried on by petitioner was conducted by a partnership from 1869 to 1902. The partnership assets, tangible and intangible, were paid in for stock having a par value much less than the value of such assets in 1902. The partnership business was nation-wide but no value has ever been set up on petitioner's books for the valuable good will acquired. In 1911 many capital additions were charged to expense. The stockholders left dividends in the business, such borrowed capital amounting to $175,224.66 in January, 1919. For 1919 respondent determined petitioner's invested capital to be $894,138.29, and its net income to be $767,343.30. Held that petitioner's invested capital can not be correctly determined; that an abnormal condition existed between the relation of invested capital and net income; and that petitioner is entitled to have its excess-profits tax for 1919 computed pursuant to the provisions of section 328 of the Revenue Act of 1918.
*433 In this proceeding the petitioner seeks a redetermination of its income and profits-tax liability for the calendar year 1919, for which year the respondent has determined a deficiency in the amount of $3,789.41.
The sole issue is whether petitioner is entitled to have its excess-profits tax for the year 1919 computed under the provisions of section 328 of the Revenue Act of 1918.
*434 FINDINGS OF FACT.
The petitioner is a corporation, organized in 1902 under the laws of the State of Maine, with its principal office at Beverly, Mass. Ever since organization, it has been engaged in the manufacture and sale of women's shoes.
In 1869 the Woodbury brothers organized a partnership which continuously manufactured and sold shoes from that time until 1902, under the name of "Woodbury Brothers" and also "Woodbury Shoe Company." The principal place of business was at Beverly, Mass., but the partnership had advertised extensively and had employed traveling salesmen, so that by 1902 it was selling shoes in all parts of the United States and it had a valuable good will. The partnership had developed numerous trade-marks under which its shoes*2394 were sold. It kept its machinery and equipment in good condition and regularly charged off depreciation. Its books have been destroyed, except for a private ledger, which shows that the partnership sales amounted to $600,829.39 during 1900 and $426,113.82 during 1901. The partnership operated at a profit, but its earnings can not now be determined, due to the destruction of the books.
In 1902 the Woodbury brothers organized the petitioner to take over the partnership business. Petitioner's authorized capital stock was 500 shares of the par value of $100 each. In August, 1902, petitioner issued $40,000 par value of its capital stock and gave its note for $5,000 to the Woodbury brothers for all of the partnership assets, both tangible and intangible. The following opening entry was made upon petitioner's books of account:
| Assets | Liabilities | ||
| Machinery | $20,000 | Notes Payable | $5,000 |
| Merchandise | 20,000 | Stock | 40,000 |
| Equity in Accounts Receivable | 5,000 | ||
| $45,000 | $45,000 |
In setting up those values, petitioner arbitrarily wrote down the partnership book values by $78,000 on machinery, which included equipment and furniture, and $80,000 on*2395 merchandise, which included raw materials, goods in process and finished goods. No value was set up for good will or trade-marks. Low capitalization was deemed advisable at that time because of state and local taxation. The petitioner continued to use the partnership trade-marks and continued to sell to the former partnership's customers who were located in all sections of the country.
The petitioner's sales amounted to $132,334.62 for the period of August to December, 1902, inclusive; $340,828.48 for the year 1903; *435 and $191,751.07 for the period of August to December, 1905, inclusive. In 1908 petitioner's sales amounted to $534,086, and from that time there was a continuous increase in sales which amounted to $3,924,934 during 1919. During those years petitioner developed and registered in the United States Patent Office a number of trademarks which were used for various periods of time, the cost of which was charged to general expense, and can not now be segregated. From 1902 to 1918 petitioner expended between $50,000 and $80,000 for advertising, which was charged to general expense.
In 1911 petitioner employed engineers to reorganize and modernize its plant. *2396 Prior to that time its plant occupied two floors of a building and had a capacity of 1,500 to 1,800 pairs of shoes a day. After the reorganization the plant occupied five floors and had a capacity of 6,000 to 6,500 pairs of shoes a day. New machinery, equipment, electrical wiring, partitions, racks, etc., were installed at a cost in excess of $50,000, the greater portion of which was charged to general expense and can not now be segregated. Petitioner's employees installed the machinery and equipment and they were paid their regular salaries, which were charged to expense and can not now be segregated. The engineers were in charge of petitioner's plant for a period of 13 months for the purpose of the reorganization.
Prior to 1919 dividends were declared from time to time and charged to the respective accounts of the five stockholders but were left in the business. The balance credited to the stockholders in January, 1919, amounted to $175,224.66 and in December, 1919, it amounted to $181,687.
Petitioner has no amount set up on its books for intangible assets and respondent has not included any amount in its invested capital for such assets.
Petitioner has had no Government*2397 contracts. Petitioner's earnings as determined by respondent were $294,568.83 for 1917; $343,469.58 for 1918; and $767,343.30 for 1919. Petitioner's sales for those three years were:
| 1917 | $2,826,945 |
| 1918 | 3,029,262 |
| 1919 | 3,924,934 |
Respondent has granted petitioner special assessment for the year 1917 under section 210 of the Revenue Act of 1917, and also for the year 1918, under section 328 of the Revenue Act of 1918.
For the year 1919 respondent determined petitioner's invested capital to be $894,138.29 and denied its claim for special assessment.
*436 OPINION.
TRUSSELL: The petitioner contends that the facts bring it within the scope of the provisions of subdivisions (a), (c), and (d) of section 327 of the Revenue Act of 1918, and that, therefore, it is entitled to assessment pursuant to the provisions of section 328 of the said act.
Section 327 of the Revenue Act of 1918 provides:
That in the following cases the tax shall be determined as provided in section 328:
(a) Where the Commissioner is unable to determine the invested capital as provided in section 326:
* * *
(c) Where a mixed aggregate of tangible property and intangible*2398 property has been paid in for stock or for stock and bonds and the Commissioner is unable satisfactorily to determine the respective values of the several classes of property at the time of payment, or to distinguish the classes of property paid in for stock and for bonds, respectively;
(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 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, nor (2) in which 50 per centum or more of the gross income of the corporation for the taxable year (computed under section 233 of Title II) consists of gains, profits, commissions, or other income, derived*2399 on a cost-plus basis from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.
The business which petitioner is and was carrying on during 1919 was commenced in 1869 by a partnership which operated continuously until 1902. During that time fixed assets of considerable value were acquired. Also, during that period the partnership built up a nation-wide business and a valuable good will, the actual value of which can not now be determined because of the destruction of the partnership books, but the testimony is to the effect that such good will had a value of at least $50,000 in 1902. The partnership also had various trade-marks which it used on its products sold in all parts of the country. That going business and the assets, both tangible and intangible, were paid in to the petitioner for $40,000 par value of its capital stock and a note for $5,000. The actual value of those assets in 1902 can not now be determined, but we are convinced that petitioner's initial invested capital was materially *437 in excess of the par value of the capital stock issued in 1902, and that such understated invested capital has been*2400 reflected on its books through the years including the year in question, especially as to the good will, the value of which has never been included in petitioner's invested capital.
In 1911 the petitioner enlarged its plant and expended more than $50,000 in capital improvements and the greater portion of that amount was charged off to expense and can not now be segregated. Also, petitioner has developed numerous trade-marks, the cost of which has been charged off to expense.
The stockholders of petitioner have followed a practice of leaving a portion of their dividends in the business and in January, 1919, undrawn dividends credited to the five stockholders' personal accounts totaled $175,224.66 and in December, 1919, they totaled $181,687.
The respondent has computed invested capital for 1919 in the following manner:
| Capital stock outstanding Jan. 1, 1919 | $96,000.00 |
| Surplus as adjusted Jan. 1, 1919 | 786,282.45 |
| Reserves | 62,000.00 |
| 944,282.45 | |
| Less: Adjustments for prior year's taxes and inadmissible assets | 50,144.16 |
| 894,138.29 |
While it is true that some of the fixed assets acquired in the early years of the business became worn out or were replaced*2401 prior to the year 1919, it is quite apparent and we are convinced, from the record as a whole, that petitioner's invested capital for 1919 can not be definitely and accurately determined. The respondent has determined petitioner's invested capital to be $894,138.29 and its net income to be $767,343.30 for the year 1919. This, together with all the facts found, clearly shows an abnormality in the relation between invested capital and the net income which condition would work an exceptional hardship upon petitioner if its excess-profits tax should be computed without the benefit of section 328 of the Revenue Act of 1918.
We are of the opinion that petitioner's excess-profits tax for 1919 should be computed pursuant to the provisions of section 328 of the Revenue Act of 1918.
Further proceedings may be had pursuant to Rule 62(c).