1930 BTA LEXIS 2099">*2099 1. The respondent's action relative to the amount that should be included in the petitioner's invested capital on account of certain contracts involved herein, and the amounts deductible from income as allowances for the exhaustion of said contracts, sustained.
2. In the year 1921 the petitioner realized profits from the operation of a certain contract. By the terms of the contract the petitioner was required to and did expend the profits during subsequent years in experimental work. Held, said profits constituted taxable income.
3. Petitioner is not entitled to have its profits taxes for the years 1919, 1920, and 1921 computed under the provisions of sections 327 and 328 of the Revenue Acts of 1918 and 1921.
20 B.T.A. 503">*503 This proceeding is for the redetermination of deficiencies in income and excess-profits taxes asserted by the respondent in the amounts of $7,637.28 for 1919, $10,110.21 for 1920, and $56,008.83 for 1921. The petitioner alleges that the respondent erred in not1930 BTA LEXIS 2099">*2100 allowing:
(1) Any amount as paid-in surplus for invested capital purposes with respect to the value of two contracts assigned to the petitioner.
(2) Any amount as paid-in surplus for invested capital purposes with respect to the value of two contracts in payment for which the petitioner issued shares of its capital stock.
(3) Annual exhaustion in the amount of $38,101.20 on said four contracts for each taxable year.
(4) A deduction for 1921 of certain net proceeds which petitioner had agreed to use, and later did use, in experimental work.
(5) Special assessment for each taxable year.
FINDINGS OF FACT.
The petitioner was incorporated under the laws of Ohio in December, 1914. Its principal place of business is in Youngstown. For tax purposes the petitioner is affiliated with the Seiple-Wolf Construction Co., which is also an Ohio corporation located in Youngstown.
The petitioner's business consists in buying from iron and steel mills a by-product from their furnaces known as hard slag, and 20 B.T.A. 503">*504 reselling the slag after crushing and preparing it for commercial uses. This slag is used chiefly (1) in road construction, (2) as a high-grade ballast for railways, 1930 BTA LEXIS 2099">*2101 and (3) to some extent in the preparation of concrete. In localities where crushed stone is available that material is a strong competitor of hard slag. Gravel constitutes another competitor. Owing to freight charges the profitable use of both crushed stone and crushed slag is confined to territory within a radius of about one hundred miles from the crushing plants.
The petitioner's business territory is eastern Ohio. That is, east of a line beginning midway between Cleveland and the northeastern corner of the State, running thence to Columbus, and from there to Portsmouth. Within that district there is but little, if any, competition from crushed stone.
According to the method of cooling, the slag appears either in granulated form or as a hard, coherent mass. It is the latter form only which had commercial value during the taxable years and prior thereto.
Before 1910 slag had no commercial value. Such as was not used by railroads for ballast was wasted. Some iron manufacturers had ample ground space for dumping their slag, but those who did not were obliged to have their slag removed. This removal was done by the railroads at first without charge, but in 1913 or1930 BTA LEXIS 2099">*2102 1914 they began to charge 15 cents per ton for the service. This charge was gradually increased until it reached 69 cents per ton.
A large amount of storage space is necessary for a slag company such as the petitioner. It is also essential that such a company have a steady supply of slag of uniform quality.
In the eastern Ohio district only three iron companies had sufficient ground space for unlimited slag storage. Two of these companies were under contract to sell their slag to the petitioner. The third, the Ohio works of the Carnegie Steel Co., was the only concern which attempted to compete with the petitioner.
When it began business the petitioner had contracts with five iron companies for the purchase of their slag. It gradually added others, and thus was able to obtain 80 to 85 per cent of the entire hard slag output of the eastern Ohio district.
The early method of salvaging slag required from six months to one year for aging before it could be used commercially, and it was practicable only to iron mills having a large amount of storage space.
In 1914 one Leon L. Beeghley devised a method known as the small-pit system, whereby hard slag could be made ready1930 BTA LEXIS 2099">*2103 for crushing within a few days, and requiring much less space than did the old system. Beeghley, W. H. Kilcawley, and W. E. Bliss together owned 50 per cent of the outstanding capital stock of the France20 B.T.A. 503">*505 Slag Co., Beeghley owning one-fourth and Kilcawley and Bliss one-eighth each. Early in 1916 withdrew from the France Slag Co. and received in exchange for their stock about $40,000 in cash, two plans of the France Slag Co. located at Canal Dover and Latonia, Ohio, and two contracts, one with the Penn Iron & Coal Co. and the other with the United Iron & Steel Co., for the purchase of Slag produced by those mills. The remaining stockholders of the France Slag Co. obtained plants owned by the company at Detroit and Toledo. The France Slag Co. at that time had invested in these plants approximately $150,000, of which $90,000 represented the Toledo and Detroit plants and $60,000 to Canal Dover and Latonia plants. The France Slag Co.'s book surplus at the close of 1914 was $125,000. About that time 25 per cent of its outstanding capital stock was sold by W. G. France to G. A. France for $100,000. In addition to the two contracts turned over to Beeghley, Kilcawley, and1930 BTA LEXIS 2099">*2104 Bliss, the France Slag Co. owned two other contracts for the purchase of slag. The four contracts were not carried on the France Slag Co.'s books at any value.
On March 18, 1916, Beeghley, Kilcawley and Bliss conveyed to the petitioner the Canal Dover and Latonia plants and equipment and the two contracts which they had secured from the France Slag Co., in consideration of $106,875 par value of the petitioner's capital stock. The Penn Iron & Coal Co. contract was valued by the petitioner at $11.640 and the United Iron & Steel Co. contract at $5,900 at the time it acquired them. At that time the Penn Iron & Coal Co. contract had a remaining life of four years and the United Iron & Steel Co. contract a remaining life of six years and five months. The principal provisions of each of these contracts were identical and were as follows:
(a)The Iron Company agreed to lease to the France Company all lands required by the France Company for its operations under the contract at a rental of $1.00 a year.
(b)The Iron Company agreed to deliver to the France Company all of its slag at the rate of Seven and one-half cents (7 1/2??) a ton of 2,000 pounds, for all slag sold by1930 BTA LEXIS 2099">*2105 the France Co. at a price of Forty Cents (40??) a ton or less, and if said slag sold at more than 40?? a ton agreed that the price would be one-half of the increased selling price over said 40?? in addition to the minimum of 7 1/2?? a ton.
(c) The France Company agreed to sell to the Iron Company all iron scrap recovered by it from the slag at the rate of Four Dollars ($4.00) a ton of 2,240 pounds.
(d)The Iron Company agreed to provide storage space for a limited quantity of crushed slag.
In the early part of 1917 both these contracts were superseded by new ones directly with the petitioner, each with a life of ten years 20 B.T.A. 503">*506 from its date. The essential terms were the same as in the first contracts, except that the price of slag to the petitioner was increased to 15 cents per ton by the Penn Co. and to 10 cents per ton by the United Co.
From the time when petitioner first acquired these contracts from Beeghley it has carried them or the superseding ones on its books at a total valuation of $17,540. The respondent has allowed this amount as invested capital.
In November, 1914, Beeghley entered into a contract with the Shenango Furnace Co. for the purchase1930 BTA LEXIS 2099">*2106 of slag from the company's No. 1 and No. 3 furnaces at Sharpsville, Pa., for a period of 35 months from and after December 1, 1914. The essential provisions of this contract were:
(a) Beeghley to have the right to grade and construct on the Shenango Company's property, two pits for the reception and chilling of molten slag.
(b)The Shenango Company agrees to turn over to Beeghley their slag recovery plant in its present condition; and Beeghley to make at his own expense whatever alterations are necessary and to keep the plant in good operative condition, and restore it to the Shenango Company in as good condition as when he received it. Beeghley to pay a rental of $200 per month.
(c)The Shenango Company agrees to sell and deliver a locomotive crane now at the plant for $5,000.00.
(d)The Shenango Company agrees to furnish all the slag produced at their No. 1 and No. 3 furnaces, payment for which is to be as follows:
15?? per gross ton for slag delivered f.o.b. cars at No. 1 Furnace.
10?? per ton for slag loaded on cars at No. 3 Furnace.
(e) Scrap iron to be recovered and sold to the Shenango Company at One Dollar ($1.00) per gross ton.
1930 BTA LEXIS 2099">*2107 (f) Beeghley shall have the right hereunder of assigning this contract to any corporation controlled by himself.
On January 5, 1915, for a nominal consideration, Beeghley assigned the foregoing contract to the petitioner. On January 1, 1916, this contract was superseded by a new one between the Shenango Furnace Co. and the petitioner, with a life of five years from its date. This second contract was superseded by a third one on January 1, 1919, with a life of ten years from its date.
On December 30, 1914, Beeghley entered into a contract with the Marting Iron & Steel Co. of Ironton, Ohio, for the handling of that company's slag. The contract was to run for ten years from its date. The essential provisions of the contract were:
(a) Beeghley to locate and operate a slag crushing plant on the property of the Marting Iron & Steel Company, Ironton, Ohio.
(b) Beeghley to furnish a suitable steam shovel and do the necessary excavating for the slag pits; the Marting Company to take care of material loaded by Beeghley in doing this work. Also the Marting Company is to take care of the track expense as well as all other expense, and work in connection with preparing1930 BTA LEXIS 2099">*2108 these pits in readiness for operation.
20 B.T.A. 503">*507 (c) The Marting Company to furnish and construct track connecting these pits with crushing plant.
(d) The Marting Company to furnish as much space as possible on their property for slag stock piles.
(e) Beeghley to furnish and construct a modern crushing and sizing plant, and furnish all tracks necessary for the operation of this plant and the stock piles, and to furnish a suitable steam shovel for loading slag from the pits into cars and to keep the pits in condition to receive at all times the slag as produced by the Marting Company.
(f) Beeghley to pay ten cents (10??) per ton for the slag in pits for a period of ten years, and obtained an option to purchase for the following ten years at fifteen cents (15??) per ton.
(g) Beeghley to reclaim as much iron as possible from the slag at cost, not to exceed one dollar ($1.00) per ton.
(h) Beeghley authorized to assign this contract.
This contract was assigned by Beeghley to the petitioner. Before the expiration of its term the contract was superseded by a new one, but its terms were not changed.
On June 12, 1914, Beeghley entered into1930 BTA LEXIS 2099">*2109 a contract with the Jackson Iron & Steel Co. of Jackson, Ohio, for the handling of that company's slag for a period of 20 years. On January 5, 1915, this contract was assigned to the petitioner for a nominal consideration, and on September 1, 1918, was superseded by a new contract running for twenty years from January 1, 1918.
On account of said five contracts petitioner was able to procure contracts with other mills in the district and to obtain control of 80 to 85 per cent of the entire slag output. The average annual output of the several companies with which the petitioner had contracts for the purchase of slag was as follows:
| Tons | |
| Penn Iron & Coal Co. | 75,000 |
| United Iron and Steel Co. | 75,000 |
| Shenango Furnace Co. | 200,000 |
| Marting Iron and Steel Co. | 200,000 |
| Jackson Iron and Steel Co | 80,000 |
| Andrews Hitchcock Iron Co | 150,000 |
| Brier Hill Steel Co | 125,000 |
| Strothers Furnace Co | 75,000 |
| United Iron and Steel Co | 75,000 |
| Sharon Steel Hoop Co | 75,000 |
| LaBelle Iron Works | 150,000 |
| Stuart Furnace Co | 75,000 |
| Wheeling Steel & Iron Co | 75,000 |
| 1,430,000 |
The basic rate paid by the petitioner to the iron companies for hard slag was 10 cents per ton, in the1930 BTA LEXIS 2099">*2110 cooling pits, and the petitioner did the loading. In some instances where the iron companies did 20 B.T.A. 503">*508 the loading, they were paid an additional 5 cents per ton for that service.
The average price received by the petitioner for its prepared slag was 70 cents per ton at first. In 1916 the price advanced to $1 per ton. The petitioner at all times obtained from 10 to 15 cents more per ton than was received by other slag companies, due to the fact that the petitioner had practically no competition in its territory, either from other slag companies or from crushed stone. In other districts there was much competition.
On April 30, 1921, the petitioner entered into a contract with the Republic Iron & Steel Co., of Youngstown, Ohio, for handling that company's output of granulated slag. The essential provisions of the contract are:
Commencing not later than May 10th, we will assume responsibility for disposal of your entire output of granulated slag, you to pay us 50?? per net ton, weight to be determined in same manner as is done when wasted to the railroads.
It is understood that you are not to be asked to make any capital expenditures but can turn the material out1930 BTA LEXIS 2099">*2111 the same as you are now doing. We are also to continue to pay the $3.00 per car for any No. 1 granulated slag ordered which will reimburse you for any unusual expense in loading this material at the pits.
It is further understood that the price of 50?? per net ton is not fixed as a permanent price for the season or for any stated time. It is understood between us that we do not know what results can be accomplished under this new plan and it is possible that we can market more of this material than we are estimating at this time. This will depend largely on the number of blast furnaces in operation during the next six months. At any rate the agreement is that the matter can be reviewed at any time you desire to see if a lower rate can be established. The intention is that the benefits from the arrangement will be divided fairly between the two companies.
At the same time we are accomplishing these results we will be developing the permanent wasting dumps and will be in shape next winter to take the output for wastage in case you are not accumulating hard slag by that time. Also, the dump will be ready to receive any other waste materials which you may have.
It is understood1930 BTA LEXIS 2099">*2112 that any surplus remaining over and above the expenses of handling this slag during the summer months will not be considered as profit, but will be used in making preparation to waste the material during the winter season and in research and experimental efforts towards finding a permanent market for the material.
The petitioner realized net proceeds amounting to $90,471.65 from its operations under this contract in 1921. The petitioner did not distribute any portion of this amount as dividends, but expended it all, during the five or six years following 1921, in research and experimental work. This amount was not included as income in the petitioner's tax return for 1921, but the respondent included it as income in his computation for that year.
20 B.T.A. 503">*509 OPINION.
MARQUETTE: The first issue raised herein is as to the amount that should be included in the petitioner's invested capital for the years 1919, 1920, and 1921 on account of the Penn Iron & Coal Co., United Iron & Steel Co., Shenango Furnace Co., Marting Iron & Steel Co., and the Jackson Iron & Steel Co. contracts set forth in the findings of fact. The respondent has adopted a value of $17,540 for the first two1930 BTA LEXIS 2099">*2113 contracts and has computed the allowance for exhaustion on that basis, but has refused to allow any amount for the three other contracts either for invested capital or as a basis for computing allowances for exhaustion.
The petitioner contends that the contracts with the Penn Iron & Coal Co. and the United Iron & Steel Co., had a total fair market value of $137,500 at the time it acquired them, and that the Marting Iron & Steel Co., the Shenango Furnace Co., and the Jackson Iron & Steel Co. contracts had a fair market value of at least $311,000 when they were assigned to the petitioner. The petitioner further claims that the depreciated values of the five contracts were $313,600 for 1919, $268,800 for 1920, and $224,000 for 1921, which should be included in invested capital for those years.
The petitioner has presented no direct evidence respecting the fair market value of any of the contracts in question, but the alleged values are reached by a series of intricate and complicated calculations, which can be best stated by quoting from the petitioner's brief:
1. The contracts had a value of at least $448,000 when assigned to the petitioner.
The discussion of the value1930 BTA LEXIS 2099">*2114 of these contracts will be offered in four steps, which are:
(a) A sale of one-fourth of the capital stock of the France Slag Company, about one year prior to the assignment, shows that two of these five contracts, by themselves, had a value of about $137,500.
(b) This value, according to Departmental rules of calculation, would be based on a premium of 11.9 cents a ton over the royalty provided in the contracts.
(c) Applying a like differential to the production of the five contracts, without considering the production from other plants over which they gave control, results in a value of $459,119.27.
(d) Taking into consideration the entire production over which these contracts gave the petitioner control, and applying a five cents per ton premium, results in a value of $448,968.86.
About the beginning of 1915 one-fourth of the capital stock of the France Slag Company was sold for $100,000. At that time the entire capital stock and surplus of the France Slag Company was $125,000. The contracts were not carried on the books of that company at any value. The company owned no land, and hence the excess of this price over book value was not reflected in1930 BTA LEXIS 2099">*2115 an 20 B.T.A. 503">*510 increase in land values. Nor was such excess reflected in any secret or hidden reserves. The only source of income of the France Slag Company was from four contracts, of which two were assigned to the petitioner.
Mr. Beeghley and his associates owned fifty per cent of the capital stock of the France Slag Company. When they left that company they received in distribution about one-half of the assets, exclusive of the contracts, and two of the four contracts of that company. Comsequently, the value of the two contracts received by Mr. Beeghley and his associates was one-half of the value of the four contracts owned by the France Slag Co.
The following calculations are based on the foregoing facts:
| Selling price - 1/4 capital stock France Slag Co. | $ 100,000 |
| Total market value capital stock France Slag Co. | 400,000 |
| Book value capital stock France Slag Co. exclusive of contracts | 125,000 |
| Market value of the four contracts | 275,000 |
Inasmuch as the distribution of assets was based upon the Penn and United contracts having a like value to the two contracts retained by the France Slag Company, it follows that the value of the two contracts assigned1930 BTA LEXIS 2099">*2116 by these individuals to the petitioner was at least $137,500.
The sale of this stock at a price which would give a value of 137,500 for the two contracts is equivalent to the payment of 11.9 cents a ton premium, as next explained.
The average annual output of these two contracts, together, was 150,000 tons. They were for a term of ten years with a renewal clause for an additional ten years, and of this twenty-year period about five years had elapsed at the time of the sale. Accordingly, these calculations will be based on an unexpired fifteen-year term. Hoskold's Formula for a present worth on a fifteen-year term basis at eight per cent and four per cent, is 0.513053.
The sale value of the contracts, as above given, was $137,500, which sum divided by 0.513053 gives $268,003.50 as the gross value of the fifteen annuities. This amount divided by fifteen, gives the value of the annuity as $17,866.90. The latter amount, $17,866.90, divided by the annual production, 150,000 tons, gives a per ton premium of 11.9 cents.
Based then on the customary methods of calculation approved by the Treasury Department, the foregoing sale of stock is equivalent to the payment of a premium1930 BTA LEXIS 2099">*2117 of 11.9 cents a ton on the production of these contracts.
The other three contracts assigned to the petitioner were on substantially the same basis as these two contracts. Production under the five contracts was as follows:
| Average annual | |
| output (tons) | |
| Penn Iron & Coal Co | 75,000 |
| United Iron and Steel Co | 75,000 |
| Shenango Furnace Co | 200,000 |
| Marting Iron & Steel Co | 200,000 |
| Jackson Iron & Steel Co | 80,000 |
| 630,000 |
Applying the same premium per ton that was determined from the sale of one-fourth of the capital stock of the France Slag Company, the following value is shown:
| Annual production of the five contracts | tons 630,000 |
| Above tonnage multiplied by 11.9 cents gives annuity of | $ 74,970.00 |
| Multiply by effective control period of contracts (10 years) | $749,700.00 |
| To get present worth by Hoskold's Formula 8 and 4 per cent, | |
| multiply by 0.612404 | $459,119.28 |
20 B.T.A. 503">*511 Another method of determining the value of these five contracts is based on the control they gave over the slag output in this district. The testimony is clear that because these five contracts gave the petitioner substantially all of the storage facilities in1930 BTA LEXIS 2099">*2118 this district, the petitioner was able to obtain other contracts and to control eighty-five per cent of the slag output. The result was that the petitioner obtained control over 1,430,000 tons annual output.
In determining the value on this basis we shall confine ourselves exclusively to the lower royalty rate which this control obtained, and shall not consider that it also enabled the company to obtain, upon sale, a price of ten or fifteen cents more than was obtained in any other district. This difference in royalty rate, supported by the testimony of three witnesses, and substantiated by the renewal rate specified in the Marting contract, was five cents a ton.
The calculation on this basis follows:
| Annual output controlled | tons 1,430,000 |
| Multiply above amount by 5?? a ton gives annuity of | $ 71,500.00 |
| Multiply by effective control period of contracts (10 years) | $ 715,000.00 |
| To get present worth by Hoskold's Formula, 8 and 4 per cent, | |
| multiply by 0.612404 | $ 448,968.86 |
Of the values above shown, we propose the last, which shows the lowest amount, that is, $448,000.00.
We respectfully submit that the facts above outlined clearly show that two of1930 BTA LEXIS 2099">*2119 these five contracts, by themselves, had a value of about $137,500 and that the value of the five contracts, computed by accredited methods of income tax practice, was at least $448,000.00 when assigned to the corporation.
Invested capital should include the value of these contracts depreciated to the beginning of each taxable year.
The years before the Board are 1919, 1920 and 1921. The 1916 value was $448,000 depreciated to the beginning of each of these years, using a ten per cent depreciation rate, would give the following amounts to be included in invested capital:
| 1919 | $313,600.00 |
| 1920 | $268,800.00 |
| 1921 | $224,000.00 |
We are of the opinion that the petitioner has wholly failed to establish for the contracts in question the value it claims. The contracts were for the purchase of raw material, which the petitioner intended to prepare for commercial use and sell. We are not advised what markets, if any, the petitioner had for its product in 1915 and 1916, nor whether the demand for that product was large or small, steady or fluctuating, increasing or decreasing. The petitioner received 70 cents per ton for its crushed slag in 1915, and received $11930 BTA LEXIS 2099">*2120 per ton in 1916. But the evidence does not disclose the cost of preparing and marketing the product, nor whether it could be sold in paying 20 B.T.A. 503">*512 quantities, nor whether any profit was realized by virtue of these contracts in question. The only proven fact upon which the petitioner bases its contention is that early in 1915, $100,000 was paid by one member of the France family to another member in exchange for 25 per cent of the France Co.'s stock. We are not convinced that such a sale, without other corroborating evidence, fixes the fair market value of all that company's stock at $400,000 as claimed. And even if the stock did have that value, it does not follow that the four slag purchase contracts then owned by the France Company equaled one another in value. We are told that that company had no source of income other than that derived under its four contracts. But how much of that income, if any, was attributable to the two contracts later acquired by the petitioner, we are not told. The record establishes a theoretical, but not an actual market value for the contracts in question.
From its inception the petitioner has carried on its books the Penn and the United1930 BTA LEXIS 2099">*2121 contracts at a total valuation of $17,540, which has been allowed by the respondent as invested capital. In our opinion the evidence does not warrant any further allowance for paid-in surplus with respect to the four contracts in question.
The second contention is that the petitioner should be allowed annual exhaustion in the amount of $44,800 upon the five contracts which we have just discussed. As the contention is based upon the petitioner's alleged values of those contracts, which values we have found were not sustained by the record, it follows that this claim for annual exhaustion of those contracts must be denied.
The next error alleged is that the respondent has included the amount of $90,471.65 as income to the petitioner for the year 1921. This amount represents the net proceeds derived during that year from a contract with the Republic Iron & Steel Co. It is contended that the amount is not taxable income because, under the terms of the contract, the petitioner had agreed that any surplus proceeds would not be treated as profit, but would be used by the petitioner in research and experimental work. These researches and experiments, if favorable in their outcome, 1930 BTA LEXIS 2099">*2122 ultimately would benefit the Republic Co. as well as the petitioner. No part of the amount in question was expended during 1921, but during subsequent years it was expended in research and experimental work.
Section 213 of the Revenue Act of 1921 provides:
SEC. 213. That for the purposes of this title (except as otherwise provided in section 233) the term "gross income" -
(a) Includes gains, profits, and income derived from salaries, wages, or compensation for personal services * * * of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, 20 B.T.A. 503">*513 or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividend, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *
It is clear that under the above statute property is impressed with the character of income according to the manner in which it is acquired. Whether any such acquisition does or does not become income is not determined by the use to which the recipient may devote the1930 BTA LEXIS 2099">*2123 property, nor by his agreement that he will or will not treat it as profit. Here, the amount in question was derived from the operation of a business contract, in the due course of business. It comes within the scope of the rule stated by the Supreme Court in : "Income may be defined as the gain derived from capital, from labor, or from both combined." See also , and .
The petitioner has cited a number of decisions by this Board, and also , in support of its contention that the amount in question was not income. In each of those cases contributions given to aid the taxpayer in establishing a factory, or in extending the service of a public utility, were held not to be income to the taxpayer. We do not question the correctness of those decisions but as they are founded on facts materially different from those now before us, we can not accept them as guiding authorities in this instance. In our opinion the respondent correctly included the amount received1930 BTA LEXIS 2099">*2124 under the Republic Co.'s contract as taxable income to the petitioner for 1921.
The last issue for our consideration is whether the petitioner is entitled to special assessment for the years 1919, 1920, and 1921. The petitioner bases its contention upon the following allegations of abnormality:
(a) Inability to satisfactorily determine invested capital.
(b) Abnormality of income arising from inability to determine exhaustion of contracts.
(c) Abnormality of income due to development work in prior years.
(d) That assets employed to produce income were not owned by the petitioner but were placed at its disposal for a nominal rental.
The provisions of section 327 of the Revenue Acts of 1918 and 1921 are identical. In so far as material here they are:
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;
* * *
(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 20 B.T.A. 503">*514 unable satisfactorily to determine the1930 BTA LEXIS 2099">*2125 respective values of the several classes of property 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 in 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 * * *.
Section 328 provides for a special manner of assessing income tax in the cases specified in section 327.
With respect to issues (a) and (b) we are of opinion that no abnormality exists. A determination that certain contracts have no value for invested capital purposes and, therefore, none for exhaustion1930 BTA LEXIS 2099">*2126 purposes, does not bring about such an abnormality as is contemplated by the statute providing for special assessment. See ; ; .
In the decision last cited we find a condition very similar to the one now before us. There, the taxpayer had a contract giving it the exclusive rights to bottle and sell Coca-Cola within a specified territory, and it derived large profits from the business. The Commissioner did not allow any value for the contract for invested capital purposes. The taxpayer claimed special assessment on the ground that its profits were largely attributable to conditions not reflected in its invested capital, namely, the ownership of a valuable contract which was its chief income-producing factor. The taxpayer argued that its contract had a value of $400,000 and, since that value was not recognized for invested capital purposes, an abnormality existed. In refusing the claim for special assessment, it was said:
Obviously, * * * the petitioner could not operate without the contract, 1930 BTA LEXIS 2099">*2127 but this does not necessarily make of the contract an income-producing asset. The same might be said of many sales or distribution contracts, * * * but the contract itself does not usually produce income; it is the operations under the contract which give rise to income. * * *
But we do not think it necessarily follows that an abnormality exists as contemplated by the statute because a corporation has an asset which is of value * * * but which may not be included in invested capital. * * * The statute specifically provides that the special assessment provisions "shall not apply in any case (1) in which the tax (computed without benefit of this section) is high merely because the corporation earned within the taxable years a high rate of profit upon a normal invested capital." * * * Abnormality 20 B.T.A. 503">*515 means at least a deviation from a normal condition. What this petitioner had in the form of an unrecognized asset (for invested capital purposes) would not seem to be other than what is normally found in concerns of a similar character.
The language just quoted is, we think, very applicable to the present proceeding. In 1930 BTA LEXIS 2099">*2128 , the petitioner enjoyed a monopoly by virtue of its contract; in the case under consideration the petitioner's contracts eliminated 80 to 85 per cent of the possible competition. In both cases the contracts were highly essential to the successful outcome of the business enterprises, but the profits realized were due to factors outside the contracts, such as a management, methods pursued, business zeal, working capital, etc. In each case the petitioner had invested capital which was determinable under section 326 of the Revenue Acts, and which was determined and credit therefor given to the taxpayer. In our opinion there is no ground in the present proceeding for granting special assessment under the petitioner's issues (a) and (b).
In issue (c) abnormality of income is claimed because of development work in prior years. Presumably the petitioner had reference to the development of markets for crushed slag, and of the use of the small pit system of treating slag at the iron furnaces. We are not advised as to the nature or amount of any expenditures made to further such development, nor whether any such1930 BTA LEXIS 2099">*2129 expenditures were charged to capital or to operating expense, nor whether petitioner's records are in such condition that any erroneous bookkeeping entries may be rectified. Clearly, the mere expenditure of money to obtain new and wider markets for one's product, or to extend the use of a favorable method of production, does not prove the existence of an abnormality. In the present instance the development of the small pit system was not accomplished through any patent or secret process. It was open to the world, free to any who might wish to use it. The record does not show that any definite amount of the petitioner's income was due to this system. In our opinion, no abnormality has been shown under issue (c). See ; .
The final allegation of abnormality is that the petitioner's income was produced by the use of assets owned by others, for which petitioner paid only a nominal rental. There is no evidence before us to indicate what would be a fair and proper rental for the facilities so used by the petitioner; but, assuming that the amount paid was greatly below the real1930 BTA LEXIS 2099">*2130 value of the facilities, we are not convinced that an abnormality existed within the meaning of the statute. 20 B.T.A. 503">*516 This Board has held that highly favorable contracts alone do not constitute abnormalities calling for special assessment. See ; .
Judgment will be entered for the respondent.