*18 Decision will be entered under Rule 50.
Petitioner corporation, capitalized at $ 1,000,000, was organized in 1898, and in that year acquired, in exchange for its capital stock, the assets of a then existing corporation, capitalized at $ 100,000, having substantially the same stockholders, but narrower corporate purposes and powers. Held, (1) petitioner is entitled to include in its equity invested capital the assets so acquired in an amount equal to its unadjusted basis for determining loss upon a sale or exchange, which basis is cost; (2) that, under the facts, the fair market value of the tangible property so acquired in 1898 was $ 134,926.34, and of the intangible property, $ 866,000; (3) that Maltine Co., 6 B. T. A. 153, is not res judicata of the present issues; and (4) that factors entering into the computation of equity invested capital which are not questioned in the deficiency notice or pleadings, but are first suggested on brief, can not be considered at issue.
*1266 The Commissioner determined a deficiency*19 in petitioner's excess profits tax for the calendar year 1942 in the amount of $ 49,394.43, resulting from his allowing to petitioner in the computation of this tax an average earning credit rather than the invested capital credit taken by petitioner in its return.
It is respondent's position that the only credit on account of invested capital which is available to petitioner is on account of capital invested by a predecessor corporation, and that an average earning credit to petitioner is larger and therefore is the credit properly allowable.
The questions presented are whether the issues here are res judicata; and, if not, whether petitioner is entitled to an equity invested capital credit computed on a basis of cost to it of intangible assets acquired from the Maltine Manufacturing Co. in 1898, and, if so, what that cost was.
FINDINGS OF FACT.
Petitioner, the Maltine Co., is a corporation organized under the laws of New York on December 1, 1897. It filed its income and excess profits tax returns for the calendar year 1942 with the collector for the second district of New York.
On February 6, 1878, a corporation known as "The Maltine Manufacturing Company" was organized in *20 New York "for the purpose of carrying on and conducting the manufacture and sale of a medical preparation known as 'Maltine' and its compounds."
Its certificate of incorporation further provided that its manufacturing operations were to be carried on in the city and county of New York.
It had an authorized capital of 1,000 shares of a par value of $ 100 each. All of these shares were issued and outstanding as of January 8, 1898, in the following names and amounts:
| Timothy L. Woodruff | 310 shares |
| Lucius H. Biglow | 385 shares |
| Rodney A. Ward | 230 shares |
| Phineas C. Lounsbury | 75 shares |
*1267 In December of 1897 petitioner was organized as a business corporation under the laws of New York. Its purposes were stated to be as follows: "The making and selling of medicinal and food products." Its principal office was at Silver Springs, Wyoming County, New York.
The authorized capital was 10,000 shares of a par value of $ 100. The incorporators and original subscribers to and holders of the capital stock, which was issued January 8, 1898, were the following:
| Timothy L. Woodruff | 3,334 shares |
| Lucius H. Biglow | 3,333 shares |
| Rodney A. Ward | 3,333 shares |
Thereafter, on the*21 same date, Timothy L. Woodruff and Rodney A. Ward caused certain of the shares issued to them to be transferred to Lucius H. Biglow and Phineas C. Lounsbury, so that thereafter the stock was held as follows:
| Timothy L. Woodruff | 3,100 shares |
| Lucius H. Biglow | 3,850 shares |
| Rodney A. Ward | 2,300 shares |
| Phineas C. Lounsbury | 750 shares |
On the same day, January 8, 1898, the Maltine Manufacturing Co. and petitioner entered into the following contract:
This Agreement, made the 8th day of January, 1898, between The Maltine Manufacturing Company, party of the first part, and The Maltine Company, party of the second part;
Whereas, The Maltine Manufacturing Company, party of the first part, is a corporation duly organized under the laws of the State of New York, for the purpose of carrying on the business of the manufacture and sale of a medicinal preparation known as Maltine and its compounds; and
Whereas, The Maltine Company, party of the second part, is a corporation duly organized under the laws of the State of New York for the purpose of carrying on the business of making and selling medicinal and food products; and
Whereas, the party of the second part is desirous of acquiring*22 all of the property, both real and personal, and the assets, business and goodwill of the party of the first part;
Now, Therefore, This Indenture Witnesseth: That it is mutually agreed by and between the said party of the first part and the party of the second part, as follows:
1. The said party of the first part doth agree to convey, sell, assign, transfer and set over unto the party of the second part all of the property of the party of the first part, both real and personal wheresoever the same may be situate, whether held by or in the name of the said party of the first part, or in trust therefor, and the business and good-will thereof, including all and singular the lands, tenements, hereditaments and appurtenances, goods, chattels, stocks, promissory notes, debts, choses in action, evidence of title, claims, demands and effects of every description belonging to said party of the first part, wheresoever the same may be situate.
*1268 2. In consideration thereof, the party of the second part agrees to issue all of its capital stock, amounting to one million dollars ($ 1,000,000) to the stockholders of the party of the first part, according to their respective interests in, *23 or holdings of, the capital stock of the party of the first part; that is to say, to Timothy L. Woodruff, thirty-one hundred shares; to Lucius H. Biglow, thirty-eight hundred and fifty shares; to Rodney A. Ward, twenty-three hundred shares, and to Phineas C. Lounsbury, seven hundred and fifty shares; said stock to be issued and delivered, fully paid and nonassessable, to the said stockholders of the party of the first part.
3. The party of the second part further agrees to assume all of the debts, liabilities and obligations of the party of the first part.
4. It is mutually agreed that the aforementioned delivery of the property, etc., of the party of the first part to the party of the second part, and the issue and delivery of the capital stock of the party of the second part to the stockholders of the party of the first part, shall take place on the 8th day of January, 1898.
In Witness Whereof, the parties hereto have hereunto caused their corporate seals to be affixed and these presents to be signed by their respective Presidents and attested by their respective Secretaries the day and year first above written.
Pursuant to the contract set out above, the Maltine Manufacturing Co. *24 on January 8, 1898, executed a deed to the real estate on which the factory was located, and on February 9, 1898, assigned to petitioner its interest in the registered trade-mark "Maltine." On December 27, 1901, it assigned to petitioner its interest in the registered trade-mark "Malto." This deed and these assignments were duly recorded.
Petitioner took possession of the real estate, equipment, and other assets of the Maltine Manufacturing Co. No steps were taken to dissolve the manufacturing company, and it was not dissolved until March 31, 1924, when its dissolution was effected by proclamation of the Governor of New York.
Following petitioner's incorporation it carried on the business and continued to manufacture all Maltine products and marketed them under labels reading "Prepared by the Maltine Manufacturing Company." Maltine is known as an "ethical" product, advertised and sold only to doctors and druggists, not to the general public. It is highly concentrated liquid extract of malt, made by a water extraction of the nutritive principals of natural grains such as barley and wheat. It is in itself highly nutritious, and it is chiefly used as a vehicle for the administration*25 of medicines and drugs which are not otherwise in palatable form. It can be used in combination with almost any variety of medicine for which there is current demand, and it has been in wide use for the seventy years since its development. Petitioner has added other products to its line from time to time.
The assets of the Maltine Manufacturing Co. as of December 31, 1897, were shown on its books as follows: *1269
| Assets | Liabilities | ||
| Patents, trade-marks, good | |||
| will | $ 100,000.00 | Capital stock | $ 100,000.00 |
| Merchandise inventory | 53,446.11 | Book accounts | 10,389.12 |
| Machinery | 51,910.21 | Due travellers | 656.63 |
| Construction | 60,180.76 | Advertising contracts | 99.72 |
| Furniture and fixtures | 2,883.00 | Bills payable | 83,000.00 |
| Real estate | 61,500.00 | Mortgages | 40,000.00 |
| Cash | 4,783.03 | ||
| Amounts with travellers | 582.39 | Total | 234,145.47 |
| Accounts receivable | 31,991.70 | Profit and loss account | 134,926.34 |
| Record books | 500.00 | ||
| Insurance paid in advance | 443.48 | Total | 369,071.81 |
| Do | 87.93 | ||
| Bills receivable | 306.26 | ||
| Suspended accounts | 456.94 | ||
| Total | 369,071.81 |
At the time of its incorporation petitioner set up on its books the assets acquired by it in exchange*26 for its capital stock as follows:
| Assets | Liabilities | ||
| Patent trade mark and | |||
| good will | $ 1,000,000.00 | Capital stock | $ 1,000,000.00 |
| Merchandise inventory | 53,446.11 | Book accounts due | |
| others | 10,389.12 | ||
| Machinery | 51,910.21 | Amount due travelers | 656.63 |
| Construction | 60,180.76 | Advertising contracts | 99.20 |
| Real estate | 61,500.00 | Bills payable | 83,000.01 |
| Office furniture and | |||
| fixtures | 2,883.00 | Mortgages | 40,000.00 |
| Cash on hand and in bank | 4,783.03 | Profit and loss account | 134,926.43 |
| Amount in hands of | |||
| travelers | 582.39 | ||
| Book accounts due company | 31,991.70 | Total | 1,269,071.81 |
| Physicians record books | 500.00 | ||
| 7nsurance paid in advance | 443.48 | ||
| Do | 87.93 | ||
| Bills receivable | 306.26 | ||
| Suspended accounts | 456.94 | ||
| Total | 1,269,071.81 |
The good will has been carried at the value of $ 1,000,000 on petitioner's books continuously since that time.
One hundred shares of petitioner's stock were sold in 1901 for $ 120 per share. Other sales were made at various times from 1906 to 1927, at prices ranging from $ 100 to $ 148 per share.
Respondent refused to allow petitioner to include in its equity invested capital the sum of $ 1,134,926.34 representing the value of the assets*27 acquired by petitioner in 1898 in consideration for the issuance of its capital stock, contending that petitioner was limited to the use of the amount of invested capital of the Maltine Manufacturing Co., which was $ 100,000, and computed petitioner's excess profits tax liability by the use of an average earnings credit because it was in excess of the credit which would be available to petitioner after the elimination of the disallowed portion of the claimed equity invested capital.
In 1927 the Board of Tax Appeals decided Maltine Co., Docket Nos. 2805 and 3967, reported at 6 B. T. A. 153, which was an appeal from a determination of a deficiency in income and excess profits taxes for 1917, 1918, and 1919 of the same corporation which is the petitioner herein. The petitioner there contended that the transaction of 1898 *1270 described hereinabove was an exchange of its stock for stock of the manufacturing company, which entitled it to include the full value of the acquired asset in its invested capital under the statute then in effect. The respondent contended it was an exchange of stock for assets, and that the intangible assets were includible*28 in invested capital only in the percentages permitted by the statute. The Board upheld the respondent's contention.
The entire record in that case was introduced in evidence at the hearing of this case. In its findings of fact, the following language is found concerning the stock of Maltine Manufacturing Co.: "The value of the stock in January, 1898, was in excess of $ 1,000,000, represented largely by intangible assets."
The value of the assets of the Maltine Manufacturing Co. on January 8, 1898, other than its patents, trade-marks, and good will, was $ 134,926.34. The value of the patents, trade-marks and good will of the Maltine Manufacturing Co. on January 8, 1898, was $ 866,000.
OPINION.
The petitioner urges that the decision of the Board of Tax Appeals in Maltine Co. v. Commissioner, Docket Nos. 2805 and 3967, promulgated February 18, 1927, and reported at 6 B. T. A. 153, makes the issues involved here res judicata.
The respondent points out that the issues are different, different revenue acts apply, and, specifically, that the basic questions here, whether the intangible assets were acquired within the meaning of the statute so as *29 to be an allowable component of invested capital, and the value of such intangibles, were not raised, litigated, or determined in the prior decision.
We agree with the respondent. The basic issue before the Board in the earlier case was whether the 1898 transaction was a purchase by petitioner of the capital stock of the manufacturing company, or of its assets, a distinction which was important under the then effective statute. No one suggested then that the transaction should be ignored for tax purposes, the question being limited to the construction thereof. The question here is not what the character of the transaction was, but whether it should be entirely disregarded for the purpose of computing invested capital under a statute materially different from the one in effect when the earlier decision was rendered. The issues are different and different tax statutes and years are involved. We must therefore conclude that the doctrine of res judicata is not applicable. See Reynard Corporation, 37 B. T. A. 552; Susanna Bixby Bryant, 2 T.C. 789">2 T. C. 789; Pelham Hall Co. v. Hassett, 147 Fed. (2d) 63.
*30 *1271 The petitioner's contention on the merits here is that it is entitled to include in its computation of its equity invested capital, under the provisions of section 718 (a) (2) of the Internal Revenue Code, the assets of Maltine Manufacturing Co. acquired by it in 1898, in consideration of the issuance of its capital stock, in an amount equal to its unadjusted basis for determining loss upon a sale or exchange; that its basis as to these assets was cost; and that its cost was $ 1,134,926.34, which was the net worth of the property paid in for its stock, under Regulations 112, section 35.718-1.
Respondent argues that the formation of a new corporate entity in 1898 by the stockholders of an existing corporation and the acquisition by the new corporation of the assets of the old corporation in exchange for the issuance of the capital stock of the new corporation do not entitle the new corporation to the use for this purpose of the cost to it of the property so acquired in excess of the original investment in the old corporation. Respondent regards such a transaction as no more than a "write up" of good will and the declaration of a stock dividend.
There is no dispute about*31 the facts of the 1898 transaction. The Maltine Manufacturing Co. had been operating with outstanding success for several years, having paid dividends for six successive years equal to a 100 percent return on the original investment, which was $ 100,000. It operated under a charter which limited its activities to "the manufacture and sale of a medical preparation known as Maltine and its compounds in the City and County of New York."
In 1897 petitioner was incorporated with a capital of $ 1,000,000, for the purpose of acquiring the assets and business of the manufacturing company. Its corporate purpose was the making and selling of medicinal and food products and its activities were not confined to any particular locality.
The Maltine Manufacturing Co. had four stockholders. Three of them became the incorporators and original stockholders of petitioner, but almost immediately, on the same date, at least, the stockholdings were so adjusted that the four stockholders of the manufacturing company held stock in petitioner in the same proportion, at the ratio of ten for one, of their holdings in the manufacturing company.
Petitioner took over the assets and the operation of the business, *32 added new products to its line at various times, and continued its highly successful operation to the present time.
There seems to be no serious doubt that if the transaction had occurred in later years it would have qualified as a tax-free reorganization, and in that case petitioner would be required to use its transferor's base for the purpose under discussion. The immediate question here, *1272 then, is whether the fact that the transaction occurred in 1898 leads to a different result.
Section 718 (a) (2) of the code provides that property acquired for stock shall be included in the computation of equity invested capital at an amount equal to its basis (unadjusted) for determining loss upon a sale or exchange.
Section 113 (a) of the code provides: "Basis (unadjusted) of property. The basis of property shall be the cost of such property; except that * * *."
There follow twenty-two exceptions to this basic rule, of which none is claimed by respondent to be applicable to the present situation. Consequently, we conclude that the petitioner's basis of the property involved here for determining loss upon a sale or exchange is cost.
One of the exceptions, found at section 113 *33 (a) (6), relates to property acquired in a tax-free exchange after February 28, 1913. It does not provide, however, for an exception where property is acquired before that date in an exchange of a character which would have been tax-free had it occurred thereafter.
Section 113 (a) (7) provides an exception where property was acquired after December 31, 1917, by a corporation in a reorganization.
Section 113 (a) (8) provides an exception where property was acquired after December 31, 1920, by a corporation by the issuance of stock or securities, or as a paid-in surplus, or contribution to capital.
Section 113 (a) (14) provides an exception in basis for determining gain on property acquired before March 1, 1913. It is silent as to basis for determining loss and respondent's regulations (Regulations 111, sec. 29.113 (a) (14)-1) explicitly recognize that fact.
These exceptions, which do not apply here, are examined because they indicate the degree of precision with which the statute provides for the varying situations for which Congress intended to make special exceptions. The inevitable conclusion is that it meant exactly what it said when it said that the basis, except for the*34 several special situations thereafter specifically set forth, should be cost. To hold petitioner's basis for determining loss to be other than cost would be to create another exception, which we conceive to be properly the task of Congress if it is to be done.
There now arises the question of the valuation of the assets acquired by petitioner as outlined above. The regulations (sec. 35.718-1 of Regulations 112) provide:
* * * *
If the basis to the taxpayer is cost and stock was issued for the property, the cost is the fair market value of such stock at the time of its issuance. If the stock had no established market value at the time of the exchange, the fair market value of the assets of the company at that time should be determined *1273 and the liabilities deducted. The resulting net worth will be deemed to represent the total value of the outstanding stock. In determining net worth for the purpose of fixing the fair market value of the stock at the time of the exchange, the property paid in for such stock shall be included in the assets at its fair market value at that time.
If stock having no established market value is issued for intangible property, and it is necessary*35 to determine the fair market value of such property, the following factors, among others, may be taken into consideration in determining such value: (a) The earnings attributable to such intangible assets while in the hands of the predecessor owner; and (b) any cash offfers for the purchase of the business, including the intangible property, at or about the time of its acquisition * * *.
There is no dispute concerning the net value of the tangible property, which is $ 134,926.34. Our inquiry is limited to the value of the intangibles, which petitioner contends was $ 1,000,000. The respondent contends they were worth considerably less, although he concedes they were valuable, and that a substantial portion of the earnings was fairly attributable thereto.
Of the two factors suggested by the regulations as proper for consideration, among others, there is no evidence here of any cash offers for the business. Respondent offered in evidence the earnings record of the old manufacturing company and computed the value of the intangibles, by the application of the formula proposed by A. R. M. 34, 2 C. B. 31, on the basis of an 8 percent return on tangibles, and*36 capitalizing the remainder at 15 percent. The result was $ 506,521.
Petitioner objects to the use of A. R. M. 34, on the ground that it has no application here; and it contends that if Docket Nos. 2805 and 3967 are not res judicata, the findings of the Board therein, containing the finding that the value of the manufacturing company's stock was in excess of $ 1,000,000, represented largely by intangibles, are at least prima facie correct, and that there is sufficient evidence in the record here to support petitioner's valuation of $ 1,000,000 for the intangibles.
With respect to petitioner's contention that A. R. M. 34 has no application, it is noted that that memorandum provides within itself that, while its suggestions "may be utilized broadly in passing upon questions of valuation," they are "not to be regarded as controlling, however, if better evidence is presented in any specific case." We think there is presently before us sufficient evidence to obviate the necessity of resorting exclusively to A. R. M. 34.
There can be no doubt that the intangibles have been shown to have had substantial value. They were set up on petitioner's books at $ 1,000,000 at the time*37 of their acquisition. The earnings of the predecessor company averaged $ 110,000 per year for the last five years of its operation, and dividends were declared in each of those years *1274 amounting to 100 percent return on the original capital. The sale of stock nearest in point of time to the critical date was on November 30, 1901, when 100 shares of petitioner's stock were sold for $ 120 per share. No sales have ever occurred for less than par. The president of the company testified that in his opinion the good will of the business was worth at least $ 1,000,000 as of January 8, 1898. The principal product of the company is adaptable for use with almost all medicines and drugs and the demand for it is continuous and stable. It does not depend for its sales on advertising to the public.
Considering all the facts, and the pertinent criteria of value, we conclude that the fair market value of the intangible assets acquired by petitioner in 1898 in exchange for its capital stock was $ 866,000.
The final contention which we must consider is advanced by respondent in his brief. He suggests that petitioner has not proved that there were not other adjustments in reduction of*38 invested capital which might result in an invested capital credit less in amount than the average earnings credit allowed by respondent, and that without proof of all the items making up its invested capital, whether questioned by respondent or not, we can not say he erred in allowing an average earnings credit rather than an invested capital credit.
No other factors involved in invested capital were mentioned in connection with this case except those which we have discussed above.
The notice of deficiency contained the following explanatory statement:
It is held that since you were organized in 1898 to take over the assets and business of The Maltine Manufacturing Company and issued therefor all your stock consisting of $ 1,000,000 par value, which was distributed to the stockholders of the old company in exchange for their stock, the increased value of the assets so acquired does not constitute a part of equity invested capital within the meaning of section 718 of the Internal Revenue Code and the alleged value of $ 1,000,000 claimed for good will at that time has therefore been eliminated from equity invested capital. As the elimination of the write-up in good will from your equity*39 invested capital caused the excess profits credit computed on the invested capital basis to be less than the credit computed on the average earnings basis, the latter basis has been used in the computation of your excess profits tax liability.
Petitioner assigned as error the respondent's action in:
(1) Refusing to include in petitioner's equity invested capital $ 1,134,926.34 representing the value of the assets acquired on January 8, 1898, in consideration of the issuance of its capital stock;
(2) In holding the value of such assets to be less than $ 1,134,926.34;
(3) In holding the value of the intangible assets so acquired to be less than $ 1,000.000;
(4) In refusing to be bound by a prior decision of the Board of Tax Appeals involving the same questions;
*1275 (5) In refusing petitioner the right to use the value of the assets at the time of acquisition in computing its equity invested capital;
(6) In eliminating from its equity invested capital the sum of $ 1,000,000 representing the value of intangibles so acquired;
(7) In determining petitioner's excess profits tax credit to be $ 74,488.33 instead of $ 119,037.46 as claimed;
(8) In determining petitioner's excess profits*40 tax credit on an income basis instead of on an invested capital basis;
(9) In holding petitioner subject to an excess profits tax for the year ended December 31, 1942.
The respondent's answer admitted the formal allegations of the petition relating to the incorporation of petitioner, the mailing of the notice of deficiency, and the filing of the petitioner's tax returns, and that the tax in controversy is a deficiency of $ 49,394.43 in excess profits tax for 1942; that petitioner acquired the assets in question in consideration of the issuance of its capital stock having an aggregate par value of $ 1,000,000 and that the tangible assets acquired had a value of $ 134,926.34; that respondent refused to be bound by the earlier decision, which petitioner contended was res judicata, and held the petitioner was not entitled to include in its equity invested capital the sum of $ 1,000,000 representing the intangible assets, but could include only the sum of $ 100,000, and inasmuch as a computation of petitioner's excess profits tax computed on such basis was less than when computed on an average earnings basis, the average earnings basis should be adopted. The answer denied all the *41 assignments of error, denied that the determination of the deficiency resulted in the allowance of an overassessment of income tax in the amount of $ 21,779.88 which will be adjusted under Rule 50; denied that the intangible assets were of the value of $ 1,000,000; denied the allegations of fact concerning the prior decision of the Board; and denied generally all allegations not specifically admitted.
The only factor entering into petitioner's computation of the invested capital credit claimed by it in its return which the respondent questioned and disallowed and which is in issue here was the inclusion in equity invested capital of the value of the assets acquired in 1898 in exchange for the issuance of its capital stock. There is nothing in the deficiency notice or in the pleadings which would suggest the other questions raised by respondent in his brief, and, therefore, we can not consider them. See Warner G. Baird, 42 B. T. A. 970, and Robert C. Coffey, 21 B. T. A. 1242, 1245.
Decision will be entered under Rule 50.