1928 BTA LEXIS 4236">*4236 1. GOOD WILL. - The cash value of the good will of the petitioner's predecessor company acquired for stock in the year 1901 determined for the purposes of invested capital.
2. INCOME TAXES OF PRIOR YEARS. - In determining the petitioner's invested capital for the year 1920 the amount of the income and profits taxes for the year 1918, when the same shall have been finally determined, should be deducted from invested capital for the year 1920 in the full amount of such taxes. The income and profits taxes for the year 1919, when the same shall have been finally determined, should be deducted from invested capital for the year 1920 in such amount as is authorized by the then existing Treasury regulations and in accord with the provisions of section 1207 of the Revenue Act of 1926.
9 B.T.A. 1376">*1377 In this proceeding the petitioner seeks a redetermination of its income and profits-tax liability for the calendar year 1920, for which the respondent has determined a deficiency of $5,804.61. The petitioner alleges error on the part of the respondent (1) in excluding1928 BTA LEXIS 4236">*4237 from invested capital a value for good will paid in to the taxpayer for capital stock, and (2) in reducing invested capital for 1920 by additional income and profits taxes alleged to be due for 1918 and 1919.
FINDINGS OF FACT.
The petitioner's predecessor company, having the same name, was organized in the year 1880 and had its principal office and place of business at Hamilton, Ohio. It then took over the assets and going business of an older organization which had for some time been engaged in the manufacture of sawmills and stationary engines. To this business it added that of the manufacture of threshing machines and portable engines, and continued thus for about three years with little success. About the year 1883 it began the manufacture of the Corliss Engine, selling the same under its adopted trade mark of Hamilton-Corliss Engine. This business proved successful and in March, 1891, this predecessor company had an authorized capital of $1,000,000 fully subscribed for. Its business continued growing and expanding, and its sales of the Corliss Engine reached as high as $700,000 a year, and in the year immediately preceding 1901 the gains and profits of the predecessor1928 BTA LEXIS 4236">*4238 company were in round figures $237,000.
Preliminary to the reorganization the assets and liabilities of the predecessor company were appraised by three disinterested appraisers, who found that the tangible assets, including cash and bills and accounts receivable, had a then value of $1,273,937.95 and that the current liabilities were $23,937.95. Prior to the making of this appraisal a group of bankers had agreed to underwrite the issue of preferred stock of the proposed successor company and had agreed 9 B.T.A. 1376">*1378 that in the capitalization of the proposed successor company the good will of the predecessor might be taken to have the value of $583,121. The appraisers accepted this estimate of the good will value.
The books of account of the predecessor company were all destroyed as a result of a flood which occurred in the year 1913 and no records of that company are now available.
The petitioner was organized as a new corporation under the laws of the State of Ohio on or about April 1, 1901, with an authorized capital of common stock, $1,000,000, and preferred stock, $1,000,000, each represented by shares of the par value of $100 per share. All of the common stock and1928 BTA LEXIS 4236">*4239 $750,000 par value of preferred stock were issued in exchange for all the properties and the going business of the predecessor company, the intangibles being included in the amount of $500,000. Five men who had been and were stockholders and directors of the predecessor company received common stock of the new company as follows:
| Shares | Par value | |
| J. C. Hooven | 4,377 | $437,700 |
| G. H. Helvey | 1,296 | 129,600 |
| C. O. Richter | 344 | 34,400 |
| G. A. Renschler | 1,989 | 198,900 |
| Henry Sohn | 1,994 | 199,400 |
| Total | 10,000 | 1,000,000 |
and the 7,500 shares of the preferred stock were, under the direction of the above named stockholders, issued to the Bankers Syndicate for distribution or sale.
The opening book entries of the petitioner condensed show its acquired assets and liabilities as follows:
| Tangible assets | $1,273,937.95 |
| Good will | 500,000.00 |
| Total | 1,773,937.95 |
| Capital stock: | |
| Common | 1,000,000.00 |
| Preferred | 750,000.00 |
| Accounts payable | 23,937.95 |
| Total | 1,773,937.95 |
The valuation of the tangible properties as above stated is not here challenged.
During the nine months from April 1 to December 31, 1901, and the calendar years 1902 and 1903, 1928 BTA LEXIS 4236">*4240 the net earnings and the average tangible assets of the petitioner were as follows:
| Year | Net earnings | Capital invested in tangible assets |
| 1901 (9 months) | $151,676.58 | $1,250,000.00 |
| 1902 | 232,215.47 | 1,367,925.58 |
| 1903 | 214,080.80 | 1,555,142.05 |
9 B.T.A. 1376">*1379 The petitioner's capital stock outstanding on March 3, 1917, was -
| Preferred stock | $797,600 |
| Common stock | 1,000,000 |
| Total | 1,797,600 |
and the same amounts of preferred and common stock were outstanding on January 1, 1920.
In making his adjustments of invested capital for the calendar year 1920 the respondent eliminated the full amount of good will, $500,000. He also eliminated the full amount of income and profits taxes paid by the petitioner for the calendar year 1918, and also $92,948.25 of a proposed additional income and profits tax for the calendar year 1918, and he further eliminated from invested capital for the year 1920 the amount of $803,556.38, computed upon the basis of a tax liability for that year of $1,906,656.06, prorated to installments in accordance with the then existing regulations. The petitioner's income and profits-tax liability for both the years 1918 and1928 BTA LEXIS 4236">*4241 1919 was at the time of the trial of this action being given consideration by the Commissioner under the provisions of sections 327 and 328 of the Revenue Act of 1918 and a final determination of the tax liability for those years had not then been made. The figures eliminated are tentative computations.
On September 26, 1925, the Commissioner issued his deficiency letter in which are recited a deficiency for the year 1920 in the amount of $5,804.61 and an overassessment for the year 1921 in the amount of $1,048.13. The deficiency letter contains no exhibit or tabulation showing how these amounts were arrived at but reference is made to a letter sent to the petitioner under date of April 8, 1925, as the basis upon which the deficiency here under review is computed. The said letter of April 8, 1925, is in the record.
The good will of the predecessor company had, at the time acquired by the petitioner for stock, a cash value of $328,000.
OPINION.
TRUSSELL: The business acquired and now owned by this petitioner was started in the year 1880. The record does not show the amount of capitalization of the original organization, but one of 9 B.T.A. 1376">*1380 the witnesses, who had1928 BTA LEXIS 4236">*4242 been with the company continuously since 1880, testified that it began with comparatively small capital and that the increase in its capital and tangible assets was due chiefly to the accumulation of earnings and profits. It is thus seen that from small beginnings in 1880 the business grew until in April, 1901, it had tangible properties of a net value of a million and a quarter dollars, that one of its chief products sold under its trademark reached a figure of annual sales of $700,000 per year and went into every part of this country, together with many sales for export. The petitioner having taken over this business and continued it along the same lines, with other additions, apparently has had an uninterrupted period of prosperity down to and including the year here under review, at the beginning of which the Commissioner found, as shown by his deficiency letter, that the company had accumulated a surplus of $3,697,402.36. The respondent's argument that the predecessor company did not have in 1901 a valuable good will does not make a very strong appeal. Although we do not have the book records of years prior to the reorganization, one of the stockholders of the predecessor1928 BTA LEXIS 4236">*4243 company testified that in the year immediately preceding the reorganization the predecessor company's profits were approximately $237,000 and that for some years prior thereto, he thought they were in the neighborhood of $200,000. The present owners took over this business in April, 1901, and continued it without much modification either as to the character of the business or its capitalization, and during the two years and nine months immediately following the reorganization, the average earnings were at the rate of $216,177, per year upon a capital investment in tangible properties averaging $1,391,022. Analyzing these figures and having given consideration to the history of this business prior to 1901 and the continued prosperity of the business since that date, we have arrived at the conclusion that the good will of the predecessor company acquired by this taxpayer for stock had on the date acquired a cash value of $328,000.
The instant case involves income and profits-tax liability for the calendar year 1920 and has been tried when the tax liability for the years 1918 and 1919 are still undetermined. Final determination of deficiency herein for the year under review will1928 BTA LEXIS 4236">*4244 be held to be made in accordance with the findings of fact hereinabove set forth, after the liability for the years 1918 and 1919 has been settled, at which time the taxes for the years 1918 and 1919 will be reflected in the adjustment of invested capital in accordance with the existing regulations and section 1207 of the Revenue Act of 1926.
Judgment will be entered upon 15 days' notice, pursuant to Rule 50.