*2626 1. The value of good will acquired by petitioner determined, and it is held that the petitioner is entitled, under the facts herein, to include the value of such good will in its invested capital.
2. A deduction from gross income for obsolescence of good will due to prohibition legislation, denied.
*265 This is an appeal from the determination of deficiencies in income and profits taxes for the years 1919 and 1920 in the amounts of $79,272.13 and $1,393.16, respectively. The issues raised are as to the amount of invested capital to which the petitioner is entitled on account of intangible property purchased for stock, and whether it is entitled to deductions from gross income in account of obsolescence of its good will.
FINDINGS OF FACT.
The petitioner is a corporation organized under the laws of the State of Pennsylvania, *2627 with its principal office at Scranton, for the purpose of manufacturing and selling alcoholic malt beverages, and it was engaged in that business until the effective date of prohibition legislation by the Federal Government.
On or about October 1, 1897, petitioner acquired the tangible and intangible assets, including good will, of the following named breweries:
| E. Robinson's Sons. | Hughes Ale Brewery. |
| M. Robinson. | Irving Cliff Brewery. |
| ScrantonBrewing Co. | Reichard & Weaver. |
| Hughes & Glennon. | John Arnold Brewery. |
| Casey & Kelly. | Peter Krantz. |
| Dickson City Brewery. | Lackawanna Brewing Co. |
and issued in exchange therefor its first mortgage bonds of the par value of $2,800,000 common stock of the par value of $2,800,000, and preferred stock of the par value of $2,800,000. The breweries so acquired were going concerns and with the exception of the Dickson City Brewery and the Lackawanna Brewery, had been successfully operated for several years prior to 1897. The Dickson Brewery appears to have been in operation for 18 months and the Lackawanna Brewery for 3 1/2 months prior to July 1, 1897. The petitioner continued the operation of the 12 breweries, making*2628 different products at each plant and selling them under the names of the individual plants. The petitioner did not manufacture any product solely under its own name. When it acquired the several breweries the petitioner also secured the services of the managers thereof, and was thus enabled to make use of the formulae and trade secrets of each concern.
The tangible property acquired by the petitioner from the 12 breweries mentioned was entered on its books of account at $2,156,685.29, *266 and the good will was entered thereon at $6,250,245.12. The cash value of the tangible property, when acquired by the petitioner, was $1,505,684.83, and the cash value of the good will was $2,202,415.20. The average annual net earnings of the 12 breweries for the 3-year period ending June 30, 1897, were $590,951.52. The net earnings for the fiscal year ending June 30, 1897, were $578,107.15.
Immediately after they were issued, the petitioner's bonds sold at par. Shortly after its organization the petitioner found it necessary to purchase some of its own stock. After some negotiations it was able to purchase 183 shares of the preferred stock at $50 per share and 183 shares of the*2629 common stock at $20 per share.
The operations of practically all of the breweries acquired by the petitioner as above set forth, continued without substantial change in the nature of their product until the effective date of national prohibition legislation. Until that time the products manufactured were advertised and sold under the trade-names and brands used prior to October 1, 1897. The bottles, casks and boxes in which they were sold were branded with the same trade-marks and labeled with the same kind of labels under which they had been previously sold. In some instances the product was sold without the trade-names and labels, and in these instances it brought at least one dollar less per barrel and from 15 to 50 cents less per case than when sold under the trade-marks and labels. When national prohibition legislation became effective the petitioner ceased the manufacture and sale of intoxicating malt beverages. Thereafter it engaged in making and selling carbonated soft drinks, as well as the manufacture and sale of a cereal beverage, all of which contained less than one-half of one per cent of alcohol. The post-prohibition products of the petitioner were not similar*2630 or related to the pre-prohibition products, and the methods of manufacture were different, especially in connection with carbonated beverages. In its new line the petitioner did not use the trade-names, trade-marks and labels theretofore used in connection with its alcoholic beverages, but advertised its new products under new trade-names and distributed them in containers bearing the new trade-names, trade-marks and labels. The old trade-marks were discarded as valueless. The new products were sold to a class of customers entirely different from those to whom the petitioner had sold its intoxicating beverages, practically all of the petitioner's old customers having discontinued business at or shortly after the effective date of prohibition legislation.
The petitioner had on its books an account known as "Special Reserve Fund." This account was created and added to from time to time in effect, by appropriation of surplus. Prior to March 1, 1913, the account, which at that time amounted to $500,000, was closed out to the good will account and as the result thereof earned *267 surplus on the books of the petitioner is understated by the amount of $500,000.
The Commissioner, *2631 upon audit of the petitioner's income and profits-tax return for the year 1920, excluded from invested capital the entire amount claimed by the taxpayer on account of good will purchased as hereinbefore set forth, and refused to allow the petitioner any deduction from gross income on account of obsolescence of its good will.
OPINION.
MARQUETTE: The first question presented for decision here is what amount, if any, the petitioner is entitled to include in its invested capital for the years 1919 and 1920, on account of good will acquired from the 12 brewing companies under the circumstances set forth in the findings of fact. The Commissioner has refused to permit the petitioner to include any amount in invested capital on account of the good will so acquired, on the ground that it had no value.
The evidence discloses that the petitioner acquired all the assets, including good will, of 12 breweries, paying therefor bonds, preferred stock and common stock, each of the par value of $2,800,000. That it acquired for these stocks and bonds, assets of substantial value, is evidenced by the fact that the bonds immediately after they were issued sold for par, and that the preferred*2632 stock and common stock sold for $50 and $20 per share, respectively. However, no amount of stock or bonds was issued specifically for tangibles or intangibles, and it is therefore necessary, if we are to arrive at a solution of the question before us, to determine the value of the two classes of assets from the evidence that has been presented. While the issue here is as to the value of the intangibles, we must, in view of the fact that the petitioner and the Commissioner can not agree as to the value of either the tangibles or intangibles, first ascertain the value of the tangibles. We are satisfied from the evidence presented that when the petitioner acquired the assets of the 12 breweries, the tangibles included therein had a fair market value of at least $1,505,684.83. While the evidence as to that value consists principally of an appraisal made in the year 1925, the appraisal was a detailed and minute one made by competent men and based upon the original inventory of the assets under consideration. Retrospective appraisals should be carefully scrutinized, and are often not of great probative value, but we are of the opinion that the appraisals involved herein, considered*2633 with the other evidence tending to establish the value of the assets, shows with reasonable certainty that the tangible assets which the petitioner acquired in exchange for its stocks and bonds, had a value of at least the amount set forth, and we so hold.
*268 Having determined the value of the tangible assets we can, by taking the earnings of the 12 breweries prior to the time they were acquired by the petitioner, and allocating them to tangibles and intangibles in accordance with the rules laid down in prior decisions of this Board, determine a value for the intangible assets. In the , and , the Board had before it the question of determining the value of a mixed aggregate of tangible and intangible property acquired by the taxpayer in exchange for stock and the assumption of certain liabilities. In determining the value of the intangibles so acquired, it was necessary to capitalize the earnings of several years immediately prior to the date the taxpayers acquired the assets. It was held that an allowance should be made for a proper return*2634 on tangibles and that the average net earnings in excess of such return should be capitalized to determine the value of the intangibles. We think that the method so adopted is proper in the instant appeal. We do not, however, agree with the contention of the petitioner that, as in the , the rates to be used should be 8 per cent on tangibles and 15 per cent on intangibles. In view of the nature of the petitioner's business, which was subject to the hazards common to all manufacturing enterprises, as well as those peculiar to itself, it appears that the rates of 10 per cent on tangibles and 20 per cent on intangibles, are proper here, and applying those rates we find that the good will acquired by the petitioner, under the circumstances set forth in the findings of fact, had a value of $2,202,415.20 on October 1, 1897.
The net earnings which we have considered in reaching this conclusion are for the 3-year period ending June 30, 1897. While it would be desirable to have before us the earnings for a longer period, we are satisfied that the values we have found for both the tangible and intangible property acquired by*2635 the petitioner, are amply supported by the evidence.
Having found the values of the tangible and intangible assets acquired by the petitioner in exchange for its bonds and stock, we must next determine to what extent the value of the intangibles may be reflected in the petitioner's invested capital for the years 1919 and 1920. In the , the facts were that the taxpayer acquired tangible and intangible property 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 *269 cash value of each class of assets at the date of acquisition, and that the intangibles so paid in for stock should be included in invested capital subject to the limitations contained in section 326(4) of the Revenue Act of 1918. Applying that rule here we must consider that the bonds were issued first for tangibles; that the bonds in excess of the value of the tangibles were issued for intangibles, and that the remainder of the intangibles*2636 were acquired for stock. We therefore find that in consideration of its bonds the petitioner acquired tangible property of the value of $1,505,684.83, and intangibles of the value of $1,294,315.17, and that for its capital stock it acquired intangibles of the value of $908,100.03. Under section 326(a)(4) of the Revenue Act of 1918, intangible property paid in for stock prior to March 3, 1917, may be included in invested capital in an amount not exceeding:
(a) The actual cash value of such property at the time paid in,
(b) The par value of the stock or shares issued therefor, or
(c) In the aggregate 25 per centum of the par value of the total stock or shares of the corporation outstanding on March 3, 1917, whichever is lowest.
Of the three limitations prescribed, the value of the intangibles is the lowest here and it therefore follows that the petitioner is entitled to include in invested capital for the years 1919 and 1920, on account of the intangibles in question, the amount of $908,100.03.
The next question is whether the petitioner is entitled to any deduction from gross income for the years 1919 and 1920 as an allowance for the obsolescence of its good will. We*2637 have heretofore held in Appeal of manhattan , and , that under the Revenue Act of 1918 a taxpayer is not entitled to any deduction from gross income on account of obsolescence of good will. Upon the authority of the decisions in those appeals the petitioner's claim for deductions from gross income on account of obsolescence of its good will is denied. See also .
It appears from the evidence presented herein that, as set forth in the findings of fact the petitioner's earned surplus is understated on its books by the amount of $500,000. Earned surplus should, therefore, be adjusted accordingly.
Reviewed by the Board.
Judgment will be entered on 15 days' notice, under Rule 50.
STERNHAGEN and MURDOCK dissent.