*2148 1. A corporation and a partnership made separate income and excess-profits tax returns for the year 1917 and each paid the tax computed on its own return. Thereafter the Commissioner required the filing of a consolidated return for such year. Upon audit of such consolidated return the Commissioner determined additional tax due by the affiliated group and was then advised that had the petitioner understood group and was then advised quested that the entire tax of the group be allocated to the partnership. The Commissioner allocated all the additional tax to the partnership, but refused to so reallocate the amounts theretofore paid. Held that in the absence of proof that there was an understanding that one of the members of the group should pay all tax assessed against the affiliated concerns, the action of the Commissioner must be approved.
2. For the taxable year petitioner is not entitled to the benefits of section 328 of the Revenue Act of 1921.
*1297 The respondent has asserted a deficiency in income and*2149 profits taxes for the year 1921 in the amount of $6,437.14. The petitioner alleges that in the determination of such deficiency the respondent erred in the following particulars:
1. The Commissioner of Internal Revenue has refused to allocate the income and profits taxes paid by Sheppard & Myers Company, petitioner, a corporation, for the calendar taxable year 1917 to Sheppard & Myers, a partnership, for the taxable year 1917 as requested by Mr. H. D. Sheppard, president of Sheppard & Myers Company, a corporation.
2. The Commissioner of Internal Revenue by his refusal to make the allocation as set forth in sub-paragraph 1 above has not determined the correct surplus and invested capital of the petitioner for the taxable year 1921 in his deficiency letter.
3. The Commissioner of Internal Revenue has also erred in not granting special assessment to this taxpayer in the year 1921 under the provisions of sections 327 and 328 of the Internal Revenue Act of 1921.
FINDINGS OF FACT.
The petitioner is a corporation with its principal office at Hanover, Pa. It was incorporated in 1901, and ever since that time has been engaged in the manufacture and sale of shoes for men and*2150 boys. From the date of its organization down to the end of the taxable year it was owned by H. D. Sheppard and C. N. Myers, each owning 50 per cent thereof, except shares of the par value of $50,000, which *1298 were issued to L. B. Sheppard, a son of H. D. Sheppard, in August, 1921.
During the years 1917 to 1921, inclusive, H. D. Sheppard and C. N. Myers were the only members of the partnership of Sheppard & Myers, each owning a one-half interest thereof. The partnership purchased the entire output of the petitioner and retailed the same to consumers in the eastern part of the United States through about 114 so-called Hanover Shoe Stores, which it established and conducted. During the years 1917 to 1921, inclusive, the petitioner business.
The petitioner fixed the prices at which it invoiced shoes to the partnership, with little or no consideration of costs of manufacture, general wholesale prices, or market conditions. From the establishment of the first retail store it was the policy of H. D. Sheppard and C. N. Myers to allow the partnership to earn the smaller part of the profits realized from the activities of the two concerns. This was for the purpose of keeping*2151 the bulk of the profits in the corporation and so to exercise direct control thereof.
The following table shows the retail prices at which certain of the boys' shoes handled by the partnership were sold, the invoice cost thereof to the partnership, the profit realized in each pair of shoes so purchased, and retailed, and the ratio of gross profit to sales prices from 1900 to 1921, inclusive:
| Date | Retail selling price | Invoice cost price | Profit | Ratio of gross profit to sales price - per cent |
| 1900 | $3.00 | $2.35 | $0.65 | 0.216 |
| 2.50 | 2.00 | .50 | .20 | |
| March, 1906 | 3.50 | 2.70 | .80 | .228 |
| 3.00 | 2.35 | .65 | .217 | |
| Jan. 1, 1915 | 3.50 | 2.70 | .80 | .228 |
| 3.00 | 2.50 | .50 | .166 | |
| August, 1916 | 3.50 | 3.00 | .50 | .142 |
| 3.00 | 2.50 | .50 | .166 | |
| Nov. 19, 1916 | 4.50 | 4.00 | .50 | .111 |
| 4.00 | 3.50 | .50 | .125 | |
| 3.50 | 3.00 | .50 | .142 | |
| 3.00 | 2.50 | .50 | .166 | |
| Aug. 1, 1918 | 4.50 | 3.50 | 1.00 | .222 |
| 4.00 | 3.00 | 1.00 | .25 | |
| 3.50 | 2.50 | 1.00 | .286 | |
| 3.00 | 2.50 | .50 | .166 | |
| July 8, 1919 | 6.00 | 5.00 | 1.00 | .166 |
| 5.00 | 4.00 | 1.00 | .20 | |
| 4.00 | 3.50 | .50 | .125 | |
| Jan. 1, 1921 | 5.00 | 4.00 | 1.00 | .20 |
| 4.50 | 3.50 | 1.00 | .222 | |
| (a) 4.00 | 3.00 | 1.00 | .25 | |
| Aug. 8, 1921 | 5.00 | 4.00 | 1.00 | .20 |
| 4.50 | 3.50 | 1.00 | .222 | |
| (a) 4.00 | 3.00 | 1.00 | .25 | |
| (a) 3.00 | 2.50 | .50 | .166 | |
| (a) 2.50 | 2.00 | .50 | .20 | |
| Aug. 21, 1921 | 5.00 | 4.00 | 1.00 | .20 |
| 4.00 | 3.10 | .90 | .225 | |
| (a) 3.50 | 2.85 | .65 | .186 | |
| (a) 3.00 | 2.50 | .50 | .166 | |
| (a) 2.50 | 2.00 | .50 | .20 |
*2152 *1299 The statistics of Sheppard & Meyers partnership in 1921, on the same basis of a survey made by the Graduate School of Business Administration of Harvard University, bureau of Business Research are:
| Sales | $6,374,939.89 | |
| Cost of goods sold | 5,068,450.54 | |
| Gross profit | 1,306,489.35 | |
| Ratio of gross profit to sales | per cent | 20.05 |
The ratio of gross profit of all firms as shown by said survey having sales over $100,000 is 29.2 per cent. Firms with sales over $250,000 are shown to have gross profit of 29.7 per cent. The partnership of Sheppard and Myers is shown to make a gross profit of at least 8.7 per cent less than the average comparable firm in the retail shoes business.
The statistics of Sheppard & Myers, Inc., for 1921, as set forth in the 60-day letter and/or the tax return and certain ratios derived therefrom are:
| Gross sales | $5,411,381.75 | |
| Net income | 1,179,364.93 | |
| Invested capital | 3,336,468.07 | |
| Profits tax | 284,303.76 | |
| Net to gross | per cent | 21.79 |
| Net to capital | do | 35.35 |
| Gross sales to capital | do | 162.00 |
| Profits tax to net | do | 24.11 |
The taxpayer derived no income during the taxable year 1921*2153 or any other year from Government cost-plus contracts.
The corporation timely made and filed its income and excess-profits tax returns for 1917 on Forms 1031 and 1103 and duly paid the taxes computed thereon in the amount of $482,104.15. For the same year the partnership made a partnership income return and a partnership excess-profits-tax return as required by law and paid the excess-profits taxes computed thereon in the amount of $24,784.
On December 1, 1920, the Commissioner advised the petitioner that the corporation and the partnership should file a consolidated income and profits-tax return for 1917. On January 13, 1921, such return was filed on Form 1120. Upon examination thereof by the Commissioner an additional tax in the amount of $25,668.05 was developed, all of which resulted from adjustments in the income of the partnership. This additional tax was allocated to the partnership and increased its proportion of tax due on the consolidated return to the amount of $48,000.45.
On March 15, 1922, the petitioner filed its corporation income and profits-tax return for 1921. Upon examination thereof the Commissioner determined the deficiency here in controversy, in*2154 the amount of $6,437.14.
*1300 OPINION.
LANSDON: The contentions of the petitioner are set forth in our preliminary statement. Alleged errors 1 and 2 relate to the same question and require no separate discussion. Petitioner claims that there was an understanding between it and the partnership that the latter should pay all the taxes due by each for the year 1917, that the Commissioner was advised of such agreement, and, notwithstanding his knowledge thereof, allocated the tax finally found to be due on the consolidated return to the two concerns in proportion to the profits realized by each, and that the effect of such procedure was to reduce the invested capital of the petitioner for the year 1921 in the amount of tax for the year 1917 that under the agreement should have been paid by the partnership.
Petitioner and the partnership made separate returns in 1917 and each paid its own taxes. Subsequently they were advised by the Commissioner that they should file a consolidated return for such year. At the time of, or shortly after the audit of the consolidated return, one of the officers of the petitioner told a representative of the Commissioner that if the partnership*2155 had known a consolidated return would be required for 1917, they would have asked that all the tax for that year be allocated to the partnership. The Commissioner allocated the additional tax found due on account of the consolidated return to the partnership, but made no change on his records as to the taxes paid under the separate returns, except to credit the amounts thereof against the tax found and assessed under the consolidated return. Petitioner has offered no evidence that any such understanding between the partnership and the corporation existed prior to the determination of additional taxes. The Commissioner allocated the entire additional tax to the partnership, but refused to reallocate the taxes already paid. In the circumstances we are of the opinion that his procedure was correct. Nor are we able to see that the payment of taxes in proportion to its portion of the income of the affiliated group results in any abnormality of invested capital in the year in which such payment was made.
The petitioner also alleges that the Commissioner erroneously refused its application for the assessment of its taxes for the year 1921 under the provisions of section 328 of the*2156 Revenue Act of 1921. The abnormality alleged as to invested capital has been disposed of by the conclusion which we have reached above. There remains only to decide whether the petitioner's policy of invoicing its products to its sales agency, the partnership, at arbitrary prices without consideration of cost of production, market prices or general conditions resulted in an abnormality of income in the year 1921. *1301 If it is a fact that the invoice prices at which the petitioner billed its products to the partnership were arbitrary and were higher than the average of such prices in the shoe business, it follows that the income of the petitioner was increased and that of the partnership decreased. It may be that this resulted in the application of surtax rates to the petitioner's income that were higher than if the total profits had been shared between the two concerns on the basis of prices based on cost of production and other pertinent elements, but if this was an abnormality, so far as we can see it does not fall within the provisions of section 327 of the Revenue Act of 1921. The total profits of the two concerns remained the same and would have been the same under*2157 any system of invoicing the products of the one as sales to the other. The alleged abnormality here was voluntarily created and could have been voluntarily avoided at any time. If there was any hardship it resulted from the free election of the petitioner to conduct its business in the way that was deemed to be most advantageous to itself. The desired result was attained and we must assume that its advantages compensated the petitioner for any small additional tax that resulted and that must have been foreseen when the policy was persisted in after the enactment of Federal income-tax laws. In our opinion the petitioner is not entitled to have its tax for 1921 computed under the provisions of section 328 of the Revenue Act of 1921.
Reviewed by the Board.
Decision will be entered under Rule 50.