1928 BTA LEXIS 3316">*3316 1. Value claimed for good will at date of acquisition disallowed for lack of evidence.
2. Petitioner reduced its inventories by the percentage of loss sustained, which percentage was determined by an actual physical inspection. Held that the percentage does not represent an arbitrary estimate and that the adjustments made by respondent were erroneous.
3. More than five years having elapsed since petitioner filed its return for 1917 without the filing of a consent in writing extending the statute, respondent is barred by the stature of limitations with respect to the deficiency asserted for 1917.
13 B.T.A. 62">*62 This proceeding is for the redetermination of deficiencies in income and profits taxes for the years 1917 to 1920, inclusive, in the following amounts:
| 1917 | $1,578.92 |
| 1918 | 80.85 |
| 1919 | 956.19 |
| 1920 | 978.79 |
The allegations of error set forth in the pleadings upon which the parties have joined issue are:
(1) Error of the respondent in disallowing good will value in the computation of invested capital amounting to $44,000;
1928 BTA LEXIS 3316">*3317 (2) Failure of the respondent to include as a part of earned surplus the sum of $26,000, representing cash received in 1905 and erroneously credited to an asset account on the books of the petitioner;
(3) The action of the respondent in disallowing certain adjustments to petitioner's inventories for the years 1918, 1919, and 1920;
(4) Error on the part of the respondent in determining a deficiency for the year 1917;
13 B.T.A. 62">*63 (5) The action of the respondent in reducing petitioner's invested capital for the taxable years in controversy on account of income and profits taxes paid or accrued during each year on the income of the preceding taxable years;
(6) Error of the respondent in reducing invested capital for years prior to and other than those years following the year in which a liability for additional taxes arose;
(7) Action of the respondent in reducing surplus by an amount representing additional income and profits taxes barred by the statute of limitations; and
(8) Error committed by the respondent in the selection of comparatives for the purpose of determining petitioner's profits taxes for the years 1918, 1919, and 1920 under the provisions of section 328 of1928 BTA LEXIS 3316">*3318 the Revenue Act of 1918.
Upon motion of respondent's counsel, acquiesced in by counsel for the petitioner, this proceeding will be limited to the good will, inventories, and statute of limitations questions. Since the hearing on the special assessment question has been postponed, pursuant to Rule 62 of the Rules of Practice before this Board, pending decision on the issues here in controversy, we have included none of the facts bearing upon that issue in our findings herein.
FINDINGS OF FACT.
The petitioner is a corporation, organized and incorporated under the laws of the State of Pennsylvania on March 31, 1904, with an authorized capitalization of $100,000, divided into 1,000 shares of common stock, par value $100 each, for the purpose of engaging in the wholesale and retail sale of lumber and to operate a planing mill for lumber and millwork, and it was so engaged during the years here in controversy.
The business of the petitioner was originally organized sometime prior to 1877 or 1878 near its present location. J. M. Hastings became the sole owner of the business in 1887, at or about which time he moved the lumber yard to the location now occupied by the petitioner. 1928 BTA LEXIS 3316">*3319 During that time the business was operated in the name of Hastings. Hastings sold the business to Joseph H. May, including all the stock of lumber in the yard, buildings and machinery used in the business, and the leasehold upon the realty, in or about 1894 for $30,000, payable $2,500 in cash and the balance in notes, all of which notes were satisfied within the succeeding three or four years. Thereafter, May operated the lumber business in the name of Ogilvie & May for a period of two or three years, when May succeeded to the rights of Ogilvie and the business was operated by May as sole owner until the date of his death in 1903. After 13 B.T.A. 62">*64 May's death, Hastings was oppointed administrator of his estate, the assets of which were the business of the petitioner and a dwelling that was unoccupied and heavily mortgaged. Hastings, acting as administrator of the estate aforesaid, sold the business, consisting of lumber in the yard, sheds and buildings, a planing mill, and machinery and equipment connected therewith, and the leaseholds upon the realty, to Frank Pierson, Albert G. Breitwieser, C. F. Ross et al., in 1903 or 1904 for $56,000, payable in cash.
The said Pierson, 1928 BTA LEXIS 3316">*3320 breitwieser, and Ross et al., organized a corporation under the laws of the State of Pennsylvania on March 31, 1904 (which is the present petitioner), obtained permission to use the decedent's name in its corporate name and transferred the business and assets to the petitioner in consideration of the issuance of $91,900 of its capital stock in the manner hereinafter set forth in the minutes of the board of directors.
The accounts receivable were not included in the sale but were collected by Hastings, as administrator of the estate of May, who realized sufficient from the sale and collections to make the value of the estate approximately $100,000. The books and records of the business conducted by Joseph H. May have been lost and a diligent search therefor failed to locate them, or a contract of sale or other written instrument evidencing the purchase of the business and assets by Pierson, Breitwieser, and Ross et al.
The business was favorably located for transportation facilities, being adjacent to the railroad and within a mile of the Allegheny River in which locality it had operated a great many years. Prior to their purchase Ross investigated May's business. May had built1928 BTA LEXIS 3316">*3321 up a very profitable business, and the petitioner has from the beginning had more or less business from his old customers.
A portion of the premises occupied under the leaseholds belonged to the Denny estate in the amount of approximately 19,092 square feet, for which an annual rental of $1,200 was paid. The lease had an unexpired term of about four years from the date of the assignment thereof from May's estate to the petitioner. When the business was purchased, Ross was assured by Hastings and by the representative of the Denny estate that the lease would be renewed when the then existing lease expired, and it was in fact renewed thereafter on March 22, 1907, for a period of 10 years beginning April 1, 1908. That portion of the premises occupied by the planing mill was held under a separate lease.
The following journal entry was made in the books of account as per minutes of a directors' meeting of April 6, 1904, recording the assets acquired by the petitioner:
| Horse and Wagon Account | $4,520.00 |
| Office Fixtures | 320.00 |
| Buildings (On leased ground) | 5,000.00 |
| Inventory (Lumber and Millwork) | 27,060.00 |
| Plant and Equipment | 11,000.00 |
| Franchise, Leasehold, Good Will | 44,000.00 |
| 91,900.00 |
1928 BTA LEXIS 3316">*3322 13 B.T.A. 62">*65 Upon resolution of the board of directors, and pursuant to approval by the stockholders, the capital stock of the petitioner was increased as set forth in the following minutes of the directors' meeting of April 27, 1904:
On motion of Edwin R. Haffner, seconded by Samuel Biggart, it was resolved that the capital stock of this company be increased from $5,000.00 to $100,000.00, such increase being authorized by the stockholders of this company, as evidenced by a duplicate return of the Judges filed with the President, and that said increase be issued as follows: $3,100.00 for cash, and the balance of $91,900.00 be issued to C. F. Ross, Samuel Biggart and Albert Breitwieser for all the property purchased by them from the Administrator of the Estate of Joseph H. May, deceased, consisting of the mill plant, the leases, lumber, horses, wagons, contracts and good will of the business formerly conducted by Joseph H. May.
On April 25, 1904, Hastings, acting for May's estate, assigned the Denny lease to the petitioner. Subsequently, and on or about May 15, 1905, a portion of the leased premises, amounting to approximately 5,374.5 square feet, was sold by said Denny's estate1928 BTA LEXIS 3316">*3323 to the Pittsburgh, Fort Wayne & Chicago Railroad Co., and in consideration for the petitioner's relinquishment to the railroad company of that portion of the premises which the railroad had purchased subject to the lease, the said company paid to petitioner the sum of $26,000. The negotiations leading up to this relinquishment of a portion of the leasehold began in the fall of 1905 and were consummated in February, 1906.
The balance sheet of the petitioner for the year ended December 31, 1904, shows the following assets and liabilities:
| Assets | |
| Accounts receivable | $30,978.52 |
| Horses, wagons, etc | 3,698.00 |
| Plant and equipment | 11,000.00 |
| Franchise and leasehold | 44,000.00 |
| Inventory | 36,698.35 |
| Bills receivable | 1,700.00 |
| Office furniture | 320.00 |
| Real estate | 5,000.00 |
| Cash in safe | 591.89 |
| Cash in bank | 3,252.53 |
| 137,239.29 | |
| Liabilities | |
| Bills payable | $11,429.65 |
| Accounts payable | 11,262.53 |
| Capital stock | 100,000.00 |
| Net gain 1904 | 14,547.11 |
| 137,239.29 |
13 B.T.A. 62">*66 The balance sheets for the years ended December 31, 1905, 1906, and 1907, show tangible assets, liabilities, and net gains as follows:
| Year | Tangible assets | Liabilities | Net gain |
| 1905 | $149,452.95 | $48,864.55 | $30,041.29 |
| 1906 | 192,982.95 | 43,273.57 | 47,620.98 |
| 1907 | 197,661.29 | 59,034.80 | 10,417.11 |
1928 BTA LEXIS 3316">*3324 At or about the time petitioner received the $26,000 from the railroad company to relinquish a portion of its leased premises, $4,000 of the Franchise and Leasehold account was charged off, and subsequently in 1908 the balance of the account was charged off. The $26,000 so received was credited directly to undivided profits account.
On or about October 5, 1904, 165 shares of petitioner's capital stock was sold by Albert G. Breitwieser to his brother C. E. Breitwieser at par, $100or per share.
Subsequent to incorporation and prior to January 1, 1917, the petitioner from time to time purchased and retired a total of $30,000 par value of its capital stock, and during 1918, 1919, and 1920 the outstanding capital stock was of a total par value of $70,000.
The petitioner's inventories for the years 1915 to 1920, inclusive, were taken by an officer and director who had been in the lumber business since 1903. He made a complete physical inventory for each year of the kinds and grades of lumber which were on hand as of December 31. Each piece of lumber in each grade was counted and was priced at cost in every year except 1920, which was priced at cost or market, whichever was1928 BTA LEXIS 3316">*3325 lower. During these years the petitioner carried a large stock of industrial lumber which was used in the factories in and around Pittsburgh, and it was necessary to have on hand a large assortment of sizes and grades in this class of lumber. Approximately 65 to 70 per cent of the lumber was exposed to the elements, which caused considerable deterioration throughout the year. The loss sustained varied each year, depending upon weather conditions during the year and the length of time the stock was kept on hand. The amount of the loss was estimated to a certain extent, but the estimate was based upon actual experience over a long period of years, and was determined irrespective of profits. The inventory on December 31, 1918, amounted to $147,517.33, and the loss sustained was estimated at 8 per cent, or $11,801.39, leaving a net inventory of $135,715.94. The total inventory on December 31, 1919, was $105,770.63. The gross inventory was reduced by an estimated loss of $8,414.70, or slightly less than 8 per cent, leaving a net inventory of $97,355.93. The total inventory on December 31, 1920, of $173,851.19 was reduced by an estimated 13 B.T.A. 62">*67 loss of 7 per cent, or $12,169.58, 1928 BTA LEXIS 3316">*3326 leaving a net inventory of $161,681.61. In computing its income for the years 1918, 1919, and 1920 the petitioner used the net inventories in the amounts shown for the respective years.
The petitioner filed its return of taxable net income for the calendar year 1917 on or before April 1, 1918, and it has not since that date filed a so-called waiver or consent in writing with respect to the assessment and collection of additional income and profits taxes for the calendar year 1917. In a communication addressed to the petitioner, dated July 20, 1925, the respondent said: "The five year period provided in section 277(a)(2) of the Revenue Act of 1924, within which assessment of tax for 1917 may be made, has expired." The respondent notified petitioner of a deficiency for 1917 by registered letter dated December 22, 1925.
The respondent disallowed all value for good will in computing the petitioner's invested capital for 1918, 1919, and 1920, and increased petitioner's income for each of these years by the amounts hereinabove stated which had been deducted by petitioner in determining its net inventory.
OPINION.
MORRIS: The petitioner is claiming a value for good will in the1928 BTA LEXIS 3316">*3327 amount of $44,000, but admits that the limitations contained in section 326(a)(4) of the Revenue Act of 1918 will operate to reduce the amount which it is entitled to include in invested capital to $17,500 since there was but $70,000 of its capital stock outstanding on March 3, 1917, and during the years in question. The respondent denies that valuable good will was acquired in exchange for petitioner's stock, and contends that the later charging off of the balancing entry supports his contention.
The record shows that the business acquired by the petitioner had been operated in the same community for a long period of time, but it fails to give us detailed facts from which we can determine the existence of good will and fix a value therefor. The mere fact that a business of the same kind has been operated in the same locality for a long period of time is not conclusive of the existence of good will. We have heretofore said in the , that "The valuation of good will is a question of fact and must be determined on the evidence in the record." An examination of the facts herein indicates to our mind that petitioner has confused1928 BTA LEXIS 3316">*3328 good will value with leasehold values.
The testimony of Ross, one of the original purchasers, and Hastings who made the sale of the business and assets as administrator of Joseph H. May's estate, shows that petitioner is not entitled to include any value for good will in its invested capital. Ross testified 13 B.T.A. 62">*68 that he made a thorough investigation of petitioner's assets and earning power and went over its list of customers with employees of Joseph H. May prior to purchasing the same. Hastings testified that he sold with full knowledge of the tangibles and intangibles which he conveyed, but that he sold rather than attempt to operate the business, and later granted the right to use the name of May to the petitioner. Prior to buying, Ross received the assurances of Hastings and the representative of the lessor that the premises which were held under lease could be released at the expiration of the then existing term. Under these circumstances the sale was consummated, the business as a whole was sold, and immediately thereafter the same assets were conveyed to the petitioner. The original entry made on the petitioner's journal, which petitioner now claims represents only1928 BTA LEXIS 3316">*3329 good will, was entitled "Franchise, Leasehold, Good will" and was admitted by Ross to be merely a balancing entry on the books. The testimony is to the effect that the business and assets were purchased for $56,000 cash but the set up on the books shows only $47,900 of the purchase price in tangible assets, unless the difference be attributed entirely to the leasehold which for invested capital purposes is a tangible asset. In addition to these facts the sale of a portion of the leased premises in 1906 for $26,000 and the subsequent charge off of the remainder of the balancing entry in 1908 after the lease had been renewed, confirm our opinion that whatever value was obtained by the petitioner over and above the consideration paid out, is to be found in the leaseholds rather than in good will. We, therefore, affirm the determination of the respondent on this issue.
In arriving at this decision we have not failed to consider our opinion in the , wherein we determined that good will existed, and then fixed a value therefor based on sales of stock subsequent to incorporation. The distinction between that case and this lies in the fact that1928 BTA LEXIS 3316">*3330 we are unable to determine that good will existed in any appreciable quantity. In that case the evidence showed the tremendous increase in production, in this case we are without satisfactory evidence as to production or earnings. The earnings for 1905, 1906, and 1907 and the sale of 165 shares of stock indicate that the business was successfully operated and that earnings were in excess of a fair return on the tangibles acquired, but on the record we are not convinced that petitioner has sustained the burden of proof.
The second issue relates to the correctness of respondent's adjustments to petitioner's inventories for 1918, 1919, and 1920. It is our opinion that such adjustments were erroneous and petitioner is entitled to reduce its inventories for each of the years in the amount of the loss sustained. The respondent evidently proceeded on the 13 B.T.A. 62">*69 theory that petitioner had arbitrarily reduced its inventories each year by a fixed percentage to cover any and all losses. The evidence is otherwise. Each year a physical inventory was carefully made by an officer and director of the petitioner, who actually counted and recorded all the lumber in stock. The amount of1928 BTA LEXIS 3316">*3331 the loss determined for each year was arrived at with the same precision and care, and represents in our opinion the best estimate which could be obtained. The fact that this estimate was stated in terms of a percentage does not detract from the uniformity or consistency of the method used. Cf.
The third point relates to the bar of the statute of limitations with respect to the deficiency asserted for 1917. It was admitted that the petitioner's return for 1917 was filed on or before April 1, 1918. The evidence shows that a so-called "waiver" has not been filed by petitioner with respect to such taxes, and that petitioner received the statutory notice of deficiency by letter dated December 22, 1925. More than five years having elapsed since the return was filed and the deficiency notice mailed, it follows that the deficiency is barred by the statute of limitations.
Further proceedings may be had under Rule 62(b) and (c).