*2211 1. Invested capital determined.
2. Special assessment denied.
*72 These proceedings are brought to redetermine the income and excessprofits taxes of the petitioner for the years 1919, 1920, and 1921 in the sums of $3,755.29, $5,157.13, and $3,226.12, respectively.
In Docket No. 21186 (for the year 1919) the petitioner alleges:
(1) That the respondent has improperly reduced its invested capital by $68,463.34;
(2) That the respondent erred in disallowing as an element of statutory invested capital subscriptions to the capital stock of the petitioner; and
*73 (3) That the respondent erroneously denied special assessment under the provisions of section 328 of the Revenue Act of 1918. At the hearing the petitioner waived its second allegation of error.
In Docket No. 14481 (for the year 1920) the petitioner alleges:
(1) That the respondent improperly reduced its invested capital by $61,828.34; and
(2) That the respondent erred in denying special assessment.
In Docket No. 18898 (for the year 1921) the petitioner alleges:
*2212 (1) That the respondent erred in reducing its invested capital by $61,702.57; and
(2) That the respondent erred in reducing its invested capital by amounts representing additional income and profits taxes for the years 1918, 1919, and 1920, aggregating $14,368.19.
The petitioner bases its right to special assessment on the following grounds:
(1) Its invested capital can not be determined.
(2) An unusually low rental was paid for the use of the plant.
(3) The principal stockholders, actively engaged in the business, were exceptionally well experienced.
(4) Employees were given the right to purchase stock.
(5) The petitioner succeeded to the good will of the Pacific Sash & Door Co.
The three cases were consolidated for hearing and decision.
FINDINGS OF FACT.
The Pacific Sash & Door Co. was a corporation organized in 1908 to engage in the manufacture and sale of sash, doors and millwork, and to succeed the Carpenter & Myles Mill & Lumber Co., operating prior to 1895, and the Western Door & Sash Co., incorporated in 1903.
The Pacific Sash & Door Co. operated with varying degrees of success until the time of its liquidation on July 31, 1918. On that date*2213 the stockholders were as follows:
| Number of | ||
| shares | ||
| Group No. 1: | ||
| William E. Hampton | 495 | |
| Group No. 2: | ||
| J. M. Carpenter | 1,427 | |
| E. A. Lewis (appointed special trustee in liquidation) | 1 | |
| John Griffin | 122 | |
| Paul Gardiner | 33 | |
| F. E. Pierce | 5 | |
| 1,588 | ||
| Group No. 3: | ||
| E. A. Nicholson | 276 | |
| C. L. Miller | 232 | |
| G. H. Nicholson | 108 | |
| C. S. Simpson | 140 | |
| J. M. Carpenter Co. | 77 | |
| C. E. Mapel | 18 | |
| A. M. Nicholson | 29 | |
| G. E. Nicholson | 29 | |
| R. B. Simpson | 8 | |
| 917 | ||
| Total shares outstanding | 3,000 |
*74 In 1918 J. M. Carpenter became very hard pressed for money in order to protect his investments in Oregon. E. A. Nicholson, a large stockholder of the corporation, suggested that the Pacific Sash & Door Co. might be liquidated in order to release cash for Carpenter's use, whereupon a liquidation plan was adopted and put into effect as of July 31, 1918. By that plan the stockholders were grouped as above, in accordance with the character of the property received by them in the liquidation. William E. Hampton received all of the real estate, buildings and certain plant equipment, such as the sprinkler system, the steam plant and the kiln, in exchange*2214 for his stock and for the further consideration of the cancellation of a debt due to him from the corporation amounting to $55,005.21. Group No. 2 received cash, the merchantable stock, accounts receivable, and the other quick assets of the corporation in exchange for their capital stock. They assumed the obligations of the old company. Group No. 3 was composed of stockholders, most of whom had been actively engaged in the operation of the business. They received the machinery, equipment, and other operating assets of the company, together with material in process of manufacture and sufficient manufactured stock to meet current orders, in exchange for their stock and the cancellation of a debt owed by the corporation to them in the sum of $23,828.61.
The merchandise and stock received by the stockholders of Group No. 3 from the Pacific Sash & Door Co. were inventoried at their cost price of $190,954.49 and were accepted in liquidation at that figure. The Machinery and operating equipment were taken over by the stockholders of Group No. 3 at $78,418.24, the net cost thereof as appearing on the books of the corporation. After the segregation and allocation of the assets of the*2215 liquidating corporation to the three several groups of its stockholders, Hampton, Carpenter, and Nicholson, representing those groups, entered into an arrangement whereby they secured participation in the assets of the corporation on an equitable basis. By that adjustment the machinery *75 and operating equipment were reduced to approximately 35 per cent less than their net book value, or $50,700.98. Installation costs amounting to $10,000 were expended but not included in these figures.
Thereupon the stockholders of Group No. 3 organized the petitioner, a new corporation, called the Pacific Door & Sash Co., which began business as of August 1, 1918, but was not formally incorporated until August 22, 1918. The stockholders of this corporation were as follows:
| Shares | |
| E. A. Nicholson | 420 |
| C. L. Miller | 381 |
| G. H. Nicholson | 169 |
| C. S. Simpson | 229 |
| J. M. Carpenter (Co.) | 100 |
| C. E. Mapel | 32 |
| A. M. Nicholson | 48 |
| G. E. Nicholson | 48 |
| R. B. Simpson | 11 |
| Pac. Sash & Door Co. (E. A. Lewis - Trustee) | 162 |
| Total shares | 1,600 |
The stock held by the Pacific Door & Sash Co. represented completed merchandise erroneously listed as belonging to Group No. 3, but*2216 actually belonging to Group No. 2 and, for convenience, was carried as a capital stock liability instead of an open account and was adjusted the following year.
The opening balance sheet of the petitioner as of August 1, 1918, was as follows:
| Assets | Liabilities and capital | ||
| Merchandise inventory | $ 109,454.49 | Accounts payable | $ 155.47 |
| Machinery and equipment | 50,700.98 | Capital stock | 160,000.00 |
| Total | 160,155.47 | Total | 160,155.47 |
At the time of the liquidation of the Pacific Sash & Door Co. Hampton orally agreed to lease to the Group No. 3 stockholders the land, buildings and equipment obtained by him in the liquidation without rental during the remainder of the year 1918 and at a rental of $500 a month for the year 1919.
In November, 1919, the petitioner and Hampton entered into an agreement of lease whereby the rental of the above property was fixed at $1,000 per month for a term of 10 years, from January 1, 1920, and the lessee was to pay all taxes and insurance. The lease also provided that the petitioner was given the option to purchase the property at any time before January 1, 1926, for $175,000 and after that date for $200,000. The property*2217 was purchased by petitioner *76 in 1924 for $175,000. The books of the Pacific Sash & Door Co. show that the original cost of the property was $151,392.43.
The petitioner used the same buildings, plant and equipment as those employed in the operation of the factory conducted by the Pacific Sash & Door Co. The gross sales of the petitioner for the five-month period during 1918 and for the years 1919 and 1920 were $195,117.56, $809,771.41, and $1,562,723.71, respectively.
With the exception of J. M. Carpenter, A. M. Nicholson and G. E. Nicholson, all the stockholders of the petitioner were actively engaged or employed in its business and had been actively engaged in the sash and door business for more than 15 years prior thereto. In 1919 and 1920 they worked very hard and at long hours in order to put the business on its feet. A special agreement was made between the petitioner and its employees whereby they could purchase the stock of the corporation at par, subject, however, to certain requirements as to repurchase.
The fair market value of the machinery and equipment, which the respondent included in the invested capital of the petitioner at $50,700.98, was $88,418.74.
*2218 The following is a comparative schedule of the invested capital and excess-profits tax of the petitioner for the years 1919 and 1920 as computed by the respondent.
| 1919 | 1920 | |
| Net income | $ 90,547.82 | $ 321,343.53 |
| Invested capital as adjusted | 150,988.38 | 239,274.36 |
| Profits tax | 27,163.78 | 114,538.04 |
| Total tax | 33,302.18 | 135,013.13 |
| Percentage of net income to invested capital | 63,188.84 | 134,299.19 |
| Percentage profits tax to net income | 29,999.00 | 35,643.48 |
OPINION.
VAN FOSSAN: There are two issues involved in these cases: (1) Whether respondent erroneously reduced the petitioner's invested capital in the years 1919, 1920, and 1921, and (2) whether respondent erred in denying special assessment for the years 1919 and 1920 under the provisions of section 327 of the Revenue Act of 1918. The reduction in invested capital during the several years is dependent upon the determination of the amount of petitioner's invested capital as of August 1, 1918.
Upon the liquidation of the old Pacific Sash & Door Co. three groups of stockholders received the various assets of that corporation in accordance with an agreement entered into among themselves. The*2219 first group, consisting of William E. Hampton alone, received the real estate; the second group, composed of J. M. Carpenter and *77 others, received the cash and liquid assets; while the third group, represented by E. A. Nicholson and C. E. Miller, received the machinery, equipment, merchandise inventories and other assets required in the manufacturing process. These three groups attempted to divide the assets of the old corporation in proportion to the amount of its stock held by them. The respondent included in the petitioner's invested capital the sum of $109,454.49 representing the net book cost and value of the merchandise inventories as determined and accepted by the Nicholson-Miller group. The respondent likewise included in the petitioner's invested capital the machinery and equipment item at $50,700.98, the value at which the Nicholson-Miller group accepted that item after having made an arbitrary reduction of approximately 35 per cent from the net book value as determined by the books of the Pacific Sash & Door Co.
The petitioner claims that the proper value of the machinery and equipment so taken over by the petitioner from the Nicholson-Miller group was $125,000. *2220 That figure, however, was at best merely an estimate or opinion offered by E. A. Nicholson, general manager of the petitioner. That estimate was supported by no evidence whatever tending to show the basis of the fair market value as alleged. No itemization of articles comprising the machinery and equipment schedule was attempted by Nicholson, nor did it appear by what process of reasoning or method of comparison he arrived at the figures stated. The record, however, discloses the figure of $78,418.74, to which may be added the sum of $10,000 representing the installation costs which were actually expended but were charged to expense rather than capital account. This figure of $78,418.74 was called the net book value. It was used as the basis on which the division of assets of the Pacific Sash & Door Co. among its several stockholders was accomplished. The merchandise inventories amounting to $109,454.49 were calculated on exactly the same basis and were so included by the respondent in the capital assets of the petitioner, to which they were transferred by the intermediate owners. No objection to such action was made by the petitioner. Therefore, we may assume that such figure*2221 represents their fair market value on August 1, 1918.
The item of $50,700.98, presumed by the respondent to represent the fair market value of the machinery and equipment of the petitioner with which it started business on August 1, 1918, has a different history. Carpenter, one of the chief stockholders of the Pacific Sash & Door Co., was badly in need of funds in order to protect certain investments in Oregon. The primary purpose of the liquidation of the old corporation was to provide such funds for him. He and the other members of his group received the cash *78 and other quick assets of the old corporation. In order to offset this practical advantage and as an inducement to group No. 3 to accomplish the proposed plan of liquidation, the machinery and equipment inventoried at $78,418.74 was reduced by approximately $35 per cent. The reduced figure did not represent its real value. On the record it appears that the real value of such property was the unreduced amount, to which the installation cost of $10,000 should be added. Under the facts as presented, we believe that $88,418.74 is a true measure of the fair market value of the capital assets of machinery and*2222 equipment determined by the respondent to be $50,700.98, and we so hold.
The respondent contends, somewhat incidentally, that the determination of invested capital comes within the provision of section 331 of the Revenue Act of 1918. That section is as follows:
In the case of the reorganization, consolidation, or change of ownership of a trade or business, or change of ownership of property, after March 3, 1917, if an interest or control in such trade or business or property of 50 per centum or more remains in the same persons, or any of them, then no asset transferred or received from the previous owner shall, for the purpose of determining invested capital, be allowed a greater value than would have been allowed under this title in computing the invested capital of such previous owner if such asset had not been so transferred or received. * * *
From an examination of the stockholdings in the two corporations it is apparent that "an interest or control in such trade or business or property of 50 per centum or more (did not remain) in the sume person or any of them." Therefore, section 331 is not applicable.
Passing to the second issue, we believe that the contention of*2223 the petitioner that it is entitled to special assessment under the provisions of section 328 of the Revenue Act of 1918 is without merit.
We have already determined that the amount of invested capital of the petitioner on August 1, 1918, should be $88,418.74 plus the uncontroverted item of $109,454.49, merchandise inventories, or a total of $197,873.23. This is, therefore, no basis for the plea of the petitioner that its invested capital can not be determined.
The petitioner maintains that by reason of the close friendly relationship between Hampton, the new owner of the plant, and the stockholders of the petitioner, an unusually low rental was charged furing the period from August 1, 1918, to June 31, 1919, inclusive. While to a degree such a condition may have existed, doubtless there were many other factors which led to the rental agreement. Hampton found himself in possession of land, buildings, and fixtures peculiarly adapted to the use of the petitioner. The machinery and equipment belonging to the petitioner were already installed therein and Hampton could well afford to contribute the use of his plant during 1918 and to charge a rental of $500 a month during 1919*2224 in *79 order to secure a tenant whose prospects of prosperity were good. To have attempted to obtain another tenant might have resulted in considerable loss to him. The business done by the petitioner during 1919 justified the execution of the lease calling for $1,000 a month rental for the period of ten years from January 1, 1920. Furthermore, we note that Hampton was not a stockholder or officer in the petitioner corporation.
We are unimpressed by the contention that the degree of skill and experience manifested by the principal stockholders of the petitioner is a basis for special assessment. We may properly assume that all officers and stockholders contributed their best services and efforts in order to earn their own salaries and to produce dividends on their stock.
Nor does the plan established by the petitioner permitting its employees to purchase its stock at par of itself entitle it to special assessment. It is a common arrangement calculated to induce the employees to render their best and most efficient service to the owner's business. We can see no such abnormality in the plan as to bring it within the purview of sections 327 and 328 of the Revenue Act*2225 of 1918.
The record reveals no evidence of the fact that the petitioner succeeded to the business and good will of the Pacific Sash & Door Co. In fact, the petitioner places particular emphasis on its assertion that the possessions and properties of all kinds belonging to the Pacific Sash & Door Co. were transferred to its stockholders, and thus the entire assets were divided and distributed among them. Only one group of those stockholders organized themselves into a corporation for the purpose of maintaining the sash and door and millwork-manufacturing business. That group incorporated under another name, quite similar, it is true, to that of the former corporation. The liquidation of the Pacific Sash & Door Co. had eliminated as assets available to the Nicholson-Miller group all cash, accounts receivable, and salable merchandise. It had removed also from the situation Carpenter and Hampton, the principal financial backers of the old company. The petitioner corporation merely occupied the premises formerly used by the Pacific Sash & Door Co. in its business. We are not convinced that there was involved any element of good will sufficient to justify the granting of special*2226 assessment.
We are unable to find that the petitioner during the years 1919 and 1920 was subject to such abnormal conditions affecting its capital as to work upon it an exceptional hardship in the imposition of excess-profits taxes in comparison with such taxes computed against average or representative concerns in like businesses.
Decision will be entered under Rule 50.