*4260 1. The Commissioner's determination denying additional depreciation reversed in part and, for lack of evidence, approved in part.
2. Special assessment denied.
*1292 This is a proceeding for the redetermination of deficiencies in income and excess-profits taxes for the calendar years 1918, 1919, 1920, and 1921 in the respective amounts of $16,976.69, $4,272.85, $2,765.26, and $2,457.83. The alleged errors finally left for our consideration were the failure of the Commissioner to allow sufficient depreciation on plant buildings, machinery, kilns, a tenement house, and a motor truck, and the failure of the Commissioner to allow special assessment of excess-profits taxes for the years 1918, 1919, and 1920, under the provisions of sections 327 and 328 of the Revenue Act of 1918. The cases were consolidated for hearing and decision.
FINDINGS OF FACT.
The petitioner is a West Virginia corporation organized May 3, 1907. It is engaged in the manufacture of semi-vitreous porcelain dinnerware and has its principal place of business at Newell, W. Va. *4261 At the date of incorporation it acquired the plant, book accounts, good will, and all the other assets of the Edwin M. Knowles China Co., an Ohio corporation, as consideration for the issuance of $150,000 par value, fully paid, nonassessable capital stock. The West Virginia corporation was organized and the Ohio corporation was dissolved for the purpose of avoiding the payment of a capital stock tax in both Ohio and West Virginia.
The Ohio corporation was incorporated in 1900, and its net tangible assets and earnings from the date of incorporation to 1906 were as follows:
| Year | Net tangible assets | Earnings |
| 1901 | $43,991.70 | $12,342.59 |
| 1902 | 112,342.59 | 21,417.49 |
| 1903 | 133,910.08 | 29,041.49 |
| 1904 | $188,151.57 | $4,474.78 |
| 1905 | 174,626.35 | 16,528.29 |
| 1906 | 168,654.64 | 24,313.40 |
*1293 Prior to 1912, the only plant owned by this petitioner was one located at Chester, W. Va. During the years 1912 and 1913 a second plant was erected at Newell, W. Va. The money used for the erection of this plant was obtained largely by the sale of capital stock. Additional capital stock in the amount of $230,894 was sold in 1912 and 1913. The issuance of this capital*4262 stock increased the petitioner's prewar invested capital for the year 1912 in the amount of $702.63 and for the year 1913 in the amount of $101,231.85. The new plant did not start operations until April, 1914, and no earnings were made from it during the prewar years.
The petitioner owned and used in the manufacture of its product during the years 1918, 1919, and 1920, a shape or design known as the "Mayflower" which was patented April 18, 1916. This design was invented by an employee of the petitioner, and the cost of its development was charged to expense on the petitioner's books. It soon became well and favorably known in the trade and has been imitated by other manufacturers. The number of dozens of ware produced in which the "Mayflower" design was used compared with the total dozens of ware produced using other designs during the years 1919 and 1920, was as follows:
| Year | Total dozens produced | Mayflower shape | Other shapes | Per cent of Mayflower |
| 1919 | 1,313,398 | 558,613 | 754,785 | 42.53 |
| 1920 | 1,469,784 | 568,596 | 901,188 | 38.69 |
In computing the petitioner's invested capital for the years 1918, 1919, and 1920, the Commissioner did not include*4263 any amount for the value of this patent.
The petitioner paid the following salaries to its officers, all of whom were stockholders:
| Amount of compensation | ||||
| Name of officer | Shares of stock | 1918 | 1919 | 1920 |
| Edwin M. Knowles, president | 1,504 | $9,000.00 | $12,000.00 | $18,000.00 |
| J. W. Irwin, secretary-treasurer | 300 | 6,000.00 | 7,000.00 | 10,000.00 |
| Joshua Poole, vice president | 308 | 416.66 | ||
| Total | 2,112 | 15,000.00 | 19,000.00 | 28,416.66 |
*1294 During these years the petitioner's total outstanding capital stock consisted of 5,000 shares, 2,827 of which were owned by the mother, a brother, and a sister of Edwin M. Knowles.
The following are the petitioner's balance sheets for the dates indicated:
| Dec. 31, 1917 | Dec. 31, 1918 | Dec. 31, 1919 | Dec. 31, 1920 | |
| ASSETS | ||||
| Cash | $68,480.58 | $66,868.42 | $73,288.38 | $56,087.16 |
| Accounts and notes receivable | 157,831.23 | 200,503.90 | 204,875.27 | 323,742.53 |
| Inventories | 312,430.80 | 295,815.15 | 312,080.31 | 361,987.41 |
| Other supplies | 4,336.93 | |||
| Liberty bonds | 10,000.00 | 79,777.21 | 175,914.27 | |
| United States Treasury certificates | 105,000.00 | 45,000.00 | ||
| Newell B. & Ry. bonds | 75,000.00 | 70,500.00 | ||
| Certificates of indebtedness | 104,636.43 | |||
| Stocks owned | 7,250.00 | 7,250.00 | ||
| Bonds owned | 80,250.00 | |||
| Land | 25,400.00 | 25,400.00 | 25,400.00 | 25,400.00 |
| Building, Chester | 40,334.85 | 40,334.85 | ||
| Building, Newell | 108,093.73 | 108,093.73 | ||
| Building, office | 21,227.88 | 21,227.88 | ||
| Machinery, Chester | 26,829.66 | 26,829.66 | ||
| Machinery, Newell | 73,343.34 | 73,343.34 | ||
| Kilns, Chester | 15,734.11 | 15,734.11 | ||
| Kilns, Newell | 40,351.49 | 40,351.49 | ||
| Tenement house | 2,500.00 | 2,500.00 | ||
| Plant and equipment | 341,784.93 | 349,455.24 | ||
| Furniture and fixtures | 3,150.00 | 3,000.00 | ||
| Railroad switch | 1,980.53 | 1,980.53 | ||
| Consumers Fuel Co., stock | 5,000.00 | 5,000.00 | ||
| Potters Mining M. Co., stock | 2,250.00 | 2,250.00 | ||
| Cleveland school bonds | 15,000.00 | |||
| Potters Savings & Loan Co., stock | 900.00 | 900.00 | ||
| Total | 914,938.20 | 1,114,119.49 | 1,225,356.10 | 1,435,573.54 |
| LIABILITIES AND CAPITAL | ||||
| Accounts payable | 1,000.00 | 5,182.51 | ||
| Notes payable | 80,250.00 | 75,000.00 | ||
| Reserve for depreciation | 27,227.88 | 48,955.76 | 69,987.36 | 91,540.92 |
| Capital stock | 500,000.00 | 500,000.00 | 500,000.00 | 500,000.00 |
| Surplus | 386,710.32 | 479,731.22 | 580,368.74 | 844,032.62 |
| Total | 914,938.20 | 1,114,119.49 | 1,225,356.10 | 1,435,573.54 |
*4264 The manufacturers confining themselves exclusively to the manufacture of semi-vitreous dinnerware are almost all located in the East Liverpool district. In this district there are about twenty-five such manufacturers. Of these twenty-five, the following six companies are the largest, based upon kiln capacity and are generally recognized as the representative companies of the industry; the ware produced by them differs only in design and pattern; each uses the same method in marketing its ware and each is in direct competition with the other:
The Homer Laughlin China Co.
The Taylor, Smith & Taylor Co.
The D. E. McNicol Pottery Co.
*1295 The Knowles, Taylor & Knowles Co.
The W. S. George Pottery Co.
The petitioner.
The amounts shown in the following tables for the various items for the various companies represent the final determination of the Commissioner for the years 1918, 1919, and 1920. The Commissioner did not compute the tax liability of any of the companies under sections 327 and 328 of the Revenue Act of 1918.
| Comparative statistics showing complete information appearing on data sheet as prepared by the Commissioner of Internal Revenue for purposeof determining whether or not relief should be afforded under section 328 | ||
| [Data assembled from the six representative concerns in the industry] | ||
| Homer Laughlin | Taylor, Smith | |
| China Co. | & Taylor Co. | |
| 1918 | ||
| Sales, less allowance | $3,533,713.19 | $869,954.61 |
| Cost of sales | 2,608,656.87 | 677,372.81 |
| Gross profit | 925,056.32 | 192,581.80 |
| Officers' compensation | 57,000.00 | 37,650.00 |
| Repairs | 72,828.66 | 4,789.37 |
| Depreciation | 41,941.27 | 4,175.12 |
| Depletion | 0 | 0 |
| Interest paid | 0 | 0 |
| Taxable income | 650,893.62 | 111,807.51 |
| Invested capital | 2,403,035.51 | 539,900.30 |
| Excess and war-profits tax | 290,972.34 | 30,040.64 |
| Total tax | 333,662.61 | 39,612.66 |
| Excess and war profits tax to taxable | ||
| income per cent | 44.70 | 26.87 |
| 1919 | ||
| Sales, less allowance | 4,042,553.45 | 1,033,703.36 |
| Cost of sales | 3,094,054.12 | 803,284.41 |
| Gross profit | 948,499.33 | 230,418.95 |
| Officers' compensation | 55,680.00 | 39,000.00 |
| Repairs | 91,189.77 | 8,358.35 |
| Depreciation | 40,612.33 | 8,000.00 |
| Depletion | 0 | 0 |
| Interest paid | 17,187.50 | 0 |
| Taxable income | 659,878.66 | 112,734.58 |
| Invested capital | 2,618,728.71 | 511,276.09 |
| Excess and war-profits tax | 116,702.66 | 15,862.37 |
| Total tax | 170,062.80 | 25,349.59 |
| Excess and war profits tax to taxable | ||
| income per cent | 17,685 | 14.07 |
| 1920 | ||
| Sales, less allowance | 5,004,165.59 | 1,234,185.36 |
| Cost of sales | 3,610,752.22 | 977,734.65 |
| Gross profit | 1,393,413.37 | 256,450.71 |
| Officers' compensation | 60,333.24 | 46,219.97 |
| Repairs | 102,214.51 | 7,940.85 |
| Depreciation | 43,406.16 | 4,371.45 |
| Depletion | 0 | 0 |
| Interest paid | 0 | 0 |
| Taxable income | 1,024,919.83 | 129,076.82 |
| Invested capital | 2,773,649.68 | 565,235.37 |
| Excess and war-profits tax | 254,043.55 | 19,377.55 |
| Total tax | 330,444.11 | 30,019.91 |
| Excess and war profits tax to taxable | ||
| income per cent | 24.79 | 15.01 |
| Comparative statistics showing complete information appearing on data sheet as prepared by the Commissioner of Internal Revenue for purposeof determining whether or not relief should be afforded under section 328 | ||||
| [Data assembled from the six representative concerns in the industry] | ||||
| D. E. McNicol | Knowles, Taylor | W. S. George | Average | Taxpayer |
| Pottery Co. | & Knowles Co. | Pottery Co. | ||
| $527,845.64 | $1,728,451.08 | $1,391,500.11 | $1,610,292.92 | $1,288,630.50 |
| 379,446.05 | 1,287,881.99 | 1,216,433.09 | 1,233,958.16 | 892,715.73 |
| 148,399.59 | 440,569.09 | 175,067.02 | 376,334.76 | 395,914.77 |
| 23,000.00 | 21,000.00 | 83,966.67 | 44,523.33 | 15,000.00 |
| 3,881.26 | 46,684.14 | (1) | 32,045.86 | 33,068.20 |
| 7,741.12 | 25,000.00 | 9,052.84 | 17,582.07 | 11,938.66 |
| 0 | 0 | 0 | 0 | 0 |
| 298.07 | 0 | 338.00 | 127.21 | 0 |
| 69,129.30 | 262,506.07 | 132,829.43 | 245,433.19 | 263,676.68 |
| 273,952.74 | 1,397,674.64 | 555,284.83 | 1,033,969.60 | 819,457.49 |
| 30,987.22 | 95,790.89 | 53,672.14 | 100,292.65 | 142.109.35 |
| 35,324.27 | 117,015.30 | 62,931.01 | 117,709.17 | 156,287.69 |
| 44.825 | 36.49 | 40.41 | 42.31 | 53.895 |
| 708,849.65 | 2,066,389.73 | 1,752,375.55 | 1,920,774.35 | 1,481,363.50 |
| 481,678.71 | 1,554,892.81 | 1,612,330.15 | 1,509,248.04 | 1,008,341.25 |
| 227,170.94 | 511,496.92 | 140,045.40 | 411,526.31 | 473,022.25 |
| 23,000.00 | 24,000.00 | 88,000.00 | 45,936.00 | 19,500.00 |
| 0 | 49,542.78 | (1) | 49,696.97 | 28,327.48 |
| 8,379.71 | 25,000.00 | 12,626.86 | 18,923.78 | 14,194.99 |
| 0 | 0 | 0 | 0 | 0 |
| 0 | 0 | 0 | 3,437.50 | 5,943.75 |
| 81,147.95 | 319,057.49 | 188,157.48 | 272,195.23 | 333,092.72 |
| 264,714.14 | 1,463,070.98 | 632,653.42 | 1,098,088.67 | 884,838.51 |
| 17,035.19 | 45,091.02 | 39,234.40 | 46,785.13 | 83,086.13 |
| 23,242.50 | 72,910.64 | 53,902.20 | 69,093.55 | 107,652.34 |
| 20.99 | 14.13 | 20.95 | 17.19 | 24.94 |
| 964,794.99 | 2,559,771.24 | 2,234,477.26 | 2,399,478.88 | 1,850,325.75 |
| 702,305.36 | 1,796,140.62 | 1,955,239.27 | 1,808,434.42 | 1,227,908.45 |
| 262,489.63 | 763,630.62 | 279,237.99 | 591,044.46 | 622,417.30 |
| 23,000.00 | 30,000.00 | 89,500.00 | 49,810.64 | 28,416.66 |
| 23,435.62 | 68,283.77 | (1) | 50,468.69 | 30,263.42 |
| 13,642.83 | 25,000.00 | 12,426.48 | 19,769.38 | 15,689.14 |
| 0 | 0 | 0 | 0 | 0 |
| 0 | 0 | 0 | 0 | 1,584.40 |
| 108,633.88 | 534,287.23 | 295,696.33 | 418,522.82 | 444,840.59 |
| 382,472.99 | 1,530,358.18 | 739,852.67 | 1,198,313.78 | 1,001.649.97 |
| 21,435.06 | 116,063.12 | 76,246.78 | 97,433.21 | 121,243.84 |
| 29,870.83 | 156,292.32 | 97,757.44 | 128,876.92 | 152,913.37 |
| 19.73 | 21.72 | 25.79 | 23.28 | 27.255 |
*1298 The petitioner's predecessors were among the first to manufacture, in America, a line of dinnerware comparable with the light English ware. During the early years of manufacture these predecessors built up a trade and many of the customers then secured have remained on the books until the present time.
The plant at Chester was built in 1889, of brick and wood construction. Its floors are mostly of wood, although some are of cement and some of brick. Part of the plant is two stories high and another three stories high, but the principal part of the plant is but one story high. The roof is of wood, covered by a tar and asphalt composition made by the Carey Roofing Co. A new roof was put on in 1919, which roof has required painting and repaining about every three years. The seams in the roof crack and break and the wood eventually rots, so that some of it has had to be replaced.
The plant at Newell was completed in November, 1914, and began operations in that year. It is mostly one story high, although part of it is higher. Nearly all of its floors are of cement. The roof is of wood and is covered with the Carey roofing material. *4267 The roof is supported by wood, except for a small area supported by steel girders. This roof required repainting about every three years. The original roof had not been replaced at the end of 1926. Due to leaks in the roof the wood supports have to be replaced every so often. A small portion of the floors in this plant is subjected to extreme heat and has to be replaced.
The petitioner's machinery consists of jiggers, blungers, agitators, glaze mills, pug mills, motors, and other similar kinds of machinery. The jigger revolves at a high rate of speed. A mold is placed on it and when the operator pulls down a tool it cuts the clay into the desired shape. Blungers are mixers which swing around and revolve at a high rate of speed, pulverizing the materials. Agitators keep the mixture constantly in motion so that the material will remain suspended and not settle in the bottom. Pug mills pug the clay to prepare it for use. Turning lathes operate at about 1,200 revolutions per minute. The plant is dusty. The dust affects the bearings and motors of the machinery. Some parts of the machinery operate in water and come in contact with gritty material. The movable parts of such*4268 machinery have to be replaced, some being replaced every two years. The stationary parts last quite a long time.
The petitioner had 7 kilns at Chester and 14 at Newell. They were of an old-fashioned type. The bottoms of the kilns have to be replaced about every 3 years. The crown also have to be replaced. Since operations were begun in 1914, and up to December, 1926, nearly all of the crowns at the Newell plant had been replaced.
*1299 The tenement house is of ordinary frame construction and has a probable life of not more than 30 years.
The motor truck is an Oldsmobile of medium size, used for transporting ware. It is operated daily over a road, part of which is in bad condition during the winter.
The Commissioner allowed depreciation at the rate of 2 per cent for each of the years in question on plant buildings. The petitioner deducted depreciation on these assets at the rate of 2 1/2 per cent.
The Commissioner allowed depreciation on machinery at the rate of 3 per cent for the year 1918, and at the rate of 5 per cent for the other years. The petitioner deducted depreciation at the rate of 10 per cent.
The Commissioner allowed depreciation on kilns*4269 at the rate of 8 1/3 per cent for the year 1918 and at the rate of 8 1/2 per cent for the remaining years. The petitioner deducted depreciation at the rate of 10 per cent.
The Commissioner allowed depreciation on the tenement house at the rate of 3 per cent and the petitioner deducted depreciation on this asset at the rate of 1 per cent for 1918 and at the rate of 5 per cent for the remaining years.
The Commissioner allowed depreciation on the motor truck at the rate of 8.2 per cent for the year 1919 and at the rate of 25 per cent for the remaining two years. The petitioner deducted various amounts for depreciation which amounted for the 3 years in question to 59.72 per cent of the cost of the asset.
In computing the depreciation allowed on kilns for the year 1919, the Commissioner made a mathematical error of $1,000 which reduced the deduction by that amount.
OPINION.
MURDOCK: The petitioner alleged that the Commissioner allowed insufficient depreciation on its plant buildings, machinery, kilns, tenement house, and motor truck. Having produced some evidence that the tenement house had a probable life of not more than 30 years, the petitioner is entitled to have a*4270 rate of 3 1/3 per cent applied to $2,500, the admitted cost of this house, and depreciation allowed accordingly.
The evidence in regard to the other assets named is entirely too indefinite and incomplete to enable us to determine whether or not the Commissioner was in error or to determine what a proper rate for any of the assets would be. We can only affirm the Commissioner's determination and correct an error of $1,000 in his calculation of 8 1/2 per cent depreciation on kilns for 1919.
The remaining question pertains to the petitioner's right to special assessment of its war-profits and excess-profits taxes under sections 327 and 328 of the Revenue Act of 1918.
*1300 Section 327 is as follows:
SEC. 327. 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;
(b) In the case a foreign corporation;
(c) Where a mixed aggregate of tangible property and intangible 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*4271 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 on a cost-plus basis from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.
The cost of the "Mayflower" patent*4272 could have been included in invested capital, but there has been no showing that its cost can not be determined, or that it had any particular value. We can see no reason for special assessment in the facts relating to this patent. The special relief given by sections 327 and 328 of the Act was not intended for those taxpayers whose invested capital is small in amount merely because they have not taken the trouble to establish the larger amount to which they are really entitled.
The petitioner alleges as another fact entitling it to special assessment that the compensation paid to its officers was unusually low, because of the stock ownership of the officers, and represented inadequate compensation for the services actually rendered. However, the evidence fails to disclose what services these officers actually rendered and it also fails to show that their compensation was inadequate for the services actually rendered. We have heretofore held that a comparison of officers' salaries in a petitioner corporation with the officers' salaries in other corporations similarly circumstanced is insufficient to show an abnormality. *4273 .
The further contention of the petitioner is that it is entitled to special assessment because of the fact that, although a considerable amount was added to its prewar invested capital, particularly in the year 1913, its prewar income included no income from these additions *1301 to its invested capital since the money was used to build additional buildings which were not operated until some time in 1914. We have not been told the average net income of the corporation for the prewar period, or the average invested capital for the prewar period. We do not know the war-profits credit allowed the petitioner in the taxable years 1918 and 1919. The facts proven account for a lower credit than might have resulted otherwise, but they may account for only a slight difference in tax and they do not show a gross disproportion in tax within the meaning of this section of the Act. Consequently, they do not establish the existence of an abnormality producing an exceptional hardship, or in any other way entitle the petitioner to special assessment.
It is clear from the evidence that the petitioner at the time of incorporation*4274 on May 3, 1907, issued its capital stock having a par value of $150,000 for the assets of its predecessor corporation. It also appears that at some time in 1906, the predecessor corporation had net tangible assets in the amount of $168,564.64. But we do not know what assets either corporation had at the time of the transfer or even what their books showed in regard to the value of these assets at the time of the transfer. Nor do we know what the Commissioner has done in regard to the petitioner's opening invested capital and we are without sufficient evidence to determine the value of the assets acquired by the petitioner from the predecessor corporation.
The petitioner asks us to determine, from the table of net tangible assets and net earnings of the predecessor company for the five-year period preceding reorganization, that intangibles in a substantial amount were transferred to the new corporation, which intangibles with the tangibles made a total consideration greatly in excess of the par value of the capital stock exchanged. Perhaps evidence is available for the satisfactory determination of the respective values of the tangibles and the intangibles received by the petitioner*4275 at the time of its organization and from this evidence the petitioner's invested capital could be increased. See , and . So far as we know the Commissioner has recognized the value, if any, of these intangibles in invested capital. See . Evidence such as this does not entitle the petitioner to special assessment, inasmuch as it fails to show that the respective values of the several classes of property at the time they were paid in for stock could not be determined satisfactorily in this case.
The comparatives produced in evidence show that the petitioner's tax liability is relatively higher for the years in question than the tax liability of the other companies, but these tables did not indicate *1302 any particular reason for the inequality. Unless it is due to some abnormality affecting capital or income, the inequality does not entitle the taxpayer to special assessment. *4276 .
From the facts before us we can not say either that the Commissioner was unable to determine invested capital as provided in section 326 or that he was unable satisfactorily to determine the respective values of the several classes of property at the time they were paid in. Neither can we say that the tax if determined without the benefit of section 328 would, owing to abnormal conditions affecting the capital or income of the corporation, work upon the corporation an exceptional hardship evidenced by a gross disproportion between the tax computed without the benefit of this section and the tax computed by reference to the representative corporations specified in section 328. Consequently, our judgment must be for the respondent on this point.
Reviewed by the Board.
Judgment will be entered in accordance with the foregoing opinion on notice of 30 days, under Rule 50.
Footnotes
1. Not segregated. ↩