*2949 In the taxable year petitioner recovered, and reported in income, almost all of a bad debt item which had been charged off and allowed as a deduction in the previous year. The amount so recovered and returned was greater than the net income determined by respondent. These facts held to result in abnormalities sufficient to entitle petitioner to special assessments.
*621 In this proceeding the petitioner seeks a redetermination of a deficiency in income and profits taxes for the calendar year 1921 in the amount of $3,844.33. While the petitioner alleged that taxes for 1919 and 1920 are in controversy, counsel for petitioner conceded at the hearing that the Board is without jurisdiction as to those years, in view of the fact that no deficiencies are asserted as to them. The first and principal error alleged is that respondent erred in not granting special assessment due to abnormalities in income and capital. The other allegation is that respondent erroneously failed to include a paid-in surplus of $15,000 in invested capital.
FINDINGS*2950 OF FACT.
Petitioner is a Pennsylvania corporation with its principal office at Pittsburgh. Its business during the year 1921 was the wholesale jobbing of supplies for mills, mines, and oil and gas wells. It was organized in 1884 and operated until about 1903, when it sold all of its assets and ceased active business. Its charter, however, was kept alive and in August, 1919, Arthur Booth purchased all the capital stock for $500.
Prior to 1917 Booth had been connected with a large public utility corporation engaged in the production and distribution of natural gas and oil, and through his duties with that company he had become acquainted with most of the large producers of gas and oil. In 1917 Booth became vice president and sales manager of the Burson Supply Co., a corporation, which was engaged in the distribution of pipe. A part of its business was the distribution of standard pipe for the Spang Chalfant Co. Both felt that the Burson Company could distribute to its advantage the oil production supplies of the Spang Chalfant Co., and so in September, 1917, he took up the matter with the latter's sales manager, who agreed to let the Burson Company distribute the oil pipe*2951 it desired to handle on the same terms as its regular distributors. No definite tonnage was agreed upon until the spring of 1918, when the Spang Chalfant Co. agreed to let the Burson Company have a maximum of 1,000 tons per month. The agreement was oral and has never been reduced to writing.
The business of the Burson Supply Co. was very profitable. Its net tangibles, that is tangibles less all liabilities, were as follows:
| January 1, 1917 | $12,900.00 |
| January 1, 1918 | 73,792.74 |
| January 1, 1919 | 110,815.05 |
| August 1, 1919 | 98,420.26 |
*622 Net income and officer's salaries were as follows:
| Net income | Officers' salaries | |
| 1917 | $33,192.74 | $8,833.32 |
| 1918 | 40,270.31 | 19,000.00 |
| Jan. 1 to July 31, 1919 | 20,398.89 | 12,833.33 |
When Booth became connected with the company he purchased some stock and gradually added to his holdings until in June or July of 1919 he owned all the stock. By resolution of the board of directors of the petitioner of September 6, 1919, the petitioner agreed to purchase and did purchase all of the assets of the Burson Supply Co., except cash and accounts receivable, for $31,399.49, which figure represented merchandise*2952 inventory taken on the basis of cost less 25 per cent. The assets so acquired included unexpired insurance, furniture and fixtures, customer's lists, and the oral agreement with the Spang Chalfant Co. for the distribution of its oil pipe. The contract, however, was not listed among the assets, nor did the list of assets contain any item of good will or other intangibles.
By resolutions of December 4, 1920, petitioner agreed to purchase from two individuals, Benjamin F. Harris and H. D. Wilson, all of the capital stock, amounting to 100 shares, of the Ross Mechanical Supply Co., a Pennsylvania corporation. Harris offered his 51 shares and it was purchased at $918 per share, with the understanding that he would be employed by petitioner at a salary of $916.66 per month for a period of three years. Wilson offered his 49 shares and it was purchased at the same price per share and with the understanding that he would be employed at a salary of $675 per month for three years. Wilson accepted, in part payment for his stock, 150 shares of stock in the petitioner at $200 per share. The salaries demanded by Harris and Wilson were reasonable amounts for their services. The transaction*2953 was recorded in petitioner's journal by the following entry:
| Debit | Credit | |
| Stocks of other companies: | ||
| Ross Mechanical Supply Co | $91,800 | |
| Voucher record - page No. 116 a/c cash | $61,800 | |
| Capital stock issued December 4, 1920 | 15,000 | |
| Paid-in surplus | 15,000 |
The agreement made by Booth with the Spang Chalfant Co. for the sale and distribution of the latter's pipe is still in effect and during the year 1921 petitioner purchased pipe from it in the amount of $173,264.86, which was paid for in cash, except for $51,633.01 *623 hereinafter set forth. Of the total purchases $138,264.86 represented carload lots shipped direct to the purchasers and billed by petitioner to the purchasers at $158,455.89. The only modification of the agreement made was that at times petitioner purchased and sold more than the 1,000 tons per month as agreed in 1918. The taking over of the agreement by petitioner was orally approved by the vice president and general manager of the Spang Chalfant Co. Under this agreement the Spang Chalfant Co. shipped the orders of petitioner's customers direct to the purchasers, which relieved petitioner of all handling, warehouse, and storage*2954 costs. The Spang Chalfant Co. shipped its product to several other distributors, all of whom maintained warehouses at or near the oil fields. Had the petitioner been required to distribute in the same manner as the other distributors it would have needed to acquire a warehouse at considerable expense and would have had to pay the costs of handling the pipe.
Petitioner's sales of Spang Chalfant Co. pipe were billed at either 2 per cent 10 days or 2 per cent sight draft against bill of lading, and practically all purchasers took advantage of the discount. Petitioner remitted to the Spang Chalfant Co. on the basis of 2 per cent discount if paid by the fifteenth of the month following shipment. It always took advantage of the discount. Through this arrangement petitioner received payment from its customers before it was required to pay the manufacturer and thereby its own capital was not needed in handling this product.
In the year 1921 petitioner had about $200,000 invested in Government securities.
In the year 1920 petitioner charged off as a bad debt the amount of $111,949.31. This amount was claimed as a deduction from 1920 income and the deduction was allowed by the*2955 respondent. Part of the pipe represented by this item was seized in transit and returned to the Spang Chalfant Co., for which it gave petitioner credit in 1921 in the amount of $51,633.01, which was much less than the price at which the pipe had originally been billed. This amount was reported in petitioner's 1921 income as an item of gross sales. Petitioner in 1921 recovered from the debtor $28,781.04, which it reported in its 1921 return as "other income" and described it as "bad debts previously charged." In 1921 it recovered the further amount of $29,993.29 out of funds of the debtor in the hands of another corporation and it returned this amount as an item of gross sales. The three items thus recovered and reported in 1921 income aggregate $110,407.34.
The respondent determined petitioner's net income for 1921 to be $109,906.84 and computed the profits tax at $28,648.51.
*624 OPINION.
ARUNDELL: When the petitioner purchased all the stock of the Ross Mechanical Supply Co. in 1920 a statutory affiliation between the two companies resulted and consequently a consolidated return of income and invested capital was required. Before consolidated invested capital*2956 can be computed, there must first be determined, in accordance with section 326 of the Revenue Act of 1918, the invested capital of each member of the affiliated group. . Whether in this case the invested capital of the Ross Mechanical Supply Co. was sufficient in amount to allow the inclusion of the $15,000 paid-in surplus claimed by the petitioner we do not know, the evidence being insufficient to establish what the invested capital of the Ross Co. was.
Petitioner claims a right to special assessment on the ground of several abnormalities affecting income and invested capital. The first is that valuable intangibles were acquired from the Burson Supply Co., which by reason of the manner in which they were acquired, can not be included in statutory invested capital. It appears from the record of the Burson Supply Co.'s earnings, when compared with its tangible assets, that it did have intangibles of substantial value. With an average of tangibles of little over $70,000, it had an average net income over the years 1917, 1918, and 1919 of about $36,000. The Burson Supply Co. was a going concern, earning substantial profits, and*2957 among its assets were customers' lists and the agreement with the Spang Chalfant Co. which were turned over to the petitioner without cost to the latter. The intangible of chief value was the agreement whereby petitioner was enabled to distribute Spang Chalfant oil pipe without handling and warehouse charges which were customary in the sale and distribution of this product. Petitioner needed no capital to handle this pipe because of the arrangement whereby it received payment from its customers in advance of the date payment was due the manufacturer. Petitioner's profit on Spang Chalfant pipe in car load lots was $20,191.03 in 1921.
In 1921 petitioner recovered through various means $110,407.34 of an item of $111,949.31 charged off as a bad debt in 1920 and allowed as a deduction from 1920 income. The entire amount recovered was reported in 1921 income. When the charge-off was made in 1920 the cost of the goods shipped was eliminated from petitioner's books, so that upon the recovery in 1921 the entire amount recovered was reported as income; there was no "cost of goods sold" which was deducted from the amount received as in the case of ordinary sales. Certainly this transaction*2958 can not be viewed as one in the ordinary course of business or as one likely to recur. The amount of petitioner's net income as determined by respondent is $109,906.84, or *625 $500.50 less than the recovery on the bad debt of the prior year. In other words, but for the recovery of the item previously charged off, all of which went into income, the petitioner would have reported no net income in the taxable year. The net income for 1921 may therefore be said to be attributable to business activities of a prior year or years.
The evidence satisfies us of the existence of abnormalities sufficient to entitle petitioner to have its profits taxes computed under section 328.
Reviewed by the Board.
Judgment will be entered under Rule 62(c).