1929 BTA LEXIS 2852">*2852 The petitioner having failed to show that there are any abnormal conditions affecting its capital or income for the year 1920, it is not entitled to have its tax for that year computed under section 328 of the Revenue Act of 1918.
15 B.T.A. 439">*439 This is a proceeding for the redetermination of a deficiency in income and excess-profits taxes for the calendar year 1920 in the amount of $19,949.54.
The petitioner alleges that the respondent erred in failing to compute the petitioner's excess-profits tax in accordance with sections 327 and 328 of the Revenue Act of 1918. It states that there was an abnormal condition affecting the invested capital of petitioner, caused as follows:
(1) By the fact that the petitioner's invested capital and net income for the year 1920 are $1,062,135.22 and $1,980,830.47, respectively, the percentage of net income to invested capital being 186 per cent, and the percentage of excess-profits tax to net income being 37 per cent;
(2) By the fact that services of large value in securing business were rendered1929 BTA LEXIS 2852">*2853 petitioner by stockholders who were paid no compensation therefor by petitioner and whose expenses in securing said business were not paid by petitioner;
15 B.T.A. 439">*440 (3) By the fact that its books and records do not contain information from which authorized allowances for obsolescence, deductible from income during 1920, may be computed; and
(4) By the fact that the petitioner made large capital expenditures in 1920, which were charged to capital accounts but useful only for the purpose of handling a temporary peak load of business during the year 1920.
The hearing of the case was limited under Rule No. 62, to a trial of the issue whether the petitioner is entitled to have its tax determined as provided in section 328 of the Revenue Act of 1918.
FINDINGS OF FACT.
The petitioner is an Illinois corporation having its principal office at Chicago. It is engaged in the business of repairing railroad cars, which is an emergency business.
The petitioner was organized on December 6, 1905, with a capital of $100,000. On April 1, 1917, a reorganization took place at which time the capitalization was increased to $2,500,000, of which $1,500,000 represented good will. The organizers1929 BTA LEXIS 2852">*2854 of petitioner were W. M. Ryan, J. M. Hopkins, W. W. Darrow, and P. M. Elliott. Ryan was a practical executive in the business of building and repairing railroad cars. Hopkins, Darrow, and Elliott had been in the business of furnishing equipment to railroads. They received no pay as officers of petitioner during 1920, nor did they receive reimbursement of expenses. Ryan was president of petitioner and managed the business.
Hopkins, Darrow, and Elliott at all times during the years 1918 to 1923, inclusive, owned or controlled at least 70 per cent of the common stock and at least 75 per cent of the preferred stock of petitioner.
The gross sales and net earnings of the petitioner as shown by its books for the years 1911 to 1925, inclusive, were as follows:
| Year | Sales | Net profits before Federal taxes | Federal taxes |
| 1911 | $76,843.77 | 1 $20,326.81 | |
| 1912 | 557,253.50 | 16,350.26 | $112.38 |
| 1913 | 740,780.22 | 76,415.37 | 756.59 |
| 1914 | 1,435,497.17 | 257,047.18 | 2,570.47 |
| 1915 | 994,692.61 | 145,387.40 | 1,439.48 |
| 1916 | 1,820,395.31 | 243,935.04 | 4,846.14 |
| 1917 | 2,375,156.48 | 222,227.24 | 55,687.48 |
| 1918 | 2,237,199.94 | 263,034.72 | 157,363.43 |
| 1919 | 2,213,318.50 | 396,083.39 | 118,300.00 |
| 1920 | 7,527,666.18 | 1,943,076.90 | 828,994.31 |
| 1921 | 2,493,958.42 | 377,049.76 | 79,885.62 |
| 1922 | 4,679,257.52 | 730,083.72 | 94,168.57 |
| 1923 | 7,585,197.31 | 534,910.92 | 74,524.22 |
| 1924 | 3,752,035.13 | 162,592.71 | 22,388.67 |
| 1925 | 4,024,242.19 | 1 94,467.24 |
15 B.T.A. 439">*441 The number of freight cars repaired by petitioner for various companies from 1916 to 1925, inclusive, was as follows:
| 1916 | 1917 | 1918 | 1919 | 1920 | 1921 | 1922 | 1923 | 1924 | 1925 | |
| B. & O.R.R | 1,885 | 887 | ||||||||
| N.Y.C.R.R. | 1,146 | 2,298 | 2,401 | 1,627 | 4,711 | 2,042 | 5,958 | 3,418 | 899 | |
| N.Y.C. & St. L.R.R. | 500 | 200 | ||||||||
| C.G.W.R.R. | 241 | 159 | 19 | |||||||
| I.C.R.R. | 300 | 682 | 1,522 | 1,036 | ||||||
| Penn. R.R | 45 | 555 | ||||||||
| Mather Stock Car Co | 350 | |||||||||
| C. & A.R.R. | 262 | |||||||||
| C.B. & Q.R.R | 500 | |||||||||
| Total | 3,031 | 3,685 | 2,401 | 2,072 | 5,266 | 2,633 | 6,799 | 5,902 | 1,954 | None. |
The number of cars repaired is not an accurate indication of the amount of work done by petitioner, since the average amount of work per car varied considerably with different lots.
In 1920 all the cars repaired by petitioner were for the New York Central Railroad and for the Pennsylvania Railroad. Of that number 4,711 were for the New York Central Railroad. There was one contract covering 4,000 cars, obtained about July, 1919, which ran for a year. Petitioner had been doing work for the New York Central1929 BTA LEXIS 2852">*2856 Railroad for a number of years. Prior to 1919 petitioner had done no work for the Pennsylvania Railroad.
During the World War the railroads of the country were under Federal control and due to the necessities brought about by the war, the rolling stock of the railroads was not kept in an average state of repair so that at the end of the war there was an abnormal condition requiring a large amount of repair work on the railroads' rolling equipment. Federal control of railroads terminated on February 29, 1920. The railroads had anticipated their return to private ownership and many orders for repairs of railroad cars were given in 1919, preceding the return, as well as in 1920.
The petitioner secured orders for repairs which resulted in gross sales by the petitioner in 1920 amounting to $7,527,666.18, on which volume of business the petitioner showed a net profit of $1,980,830.47. Hopkins, Darrow, and Elliott assisted in obtaining these orders. There was no arrangement whereby these stockholders would receive any compensation from the petitioner for their services or any reimbursement of expenses incurred by them in this connection. During the year 1921 an agreement was entered1929 BTA LEXIS 2852">*2857 into providing for reimbursement of expenses incurred thereafter in the securing of orders. In 1921, 1922, and 1923, these stockholders were reimbursed for expenses incurred as follows:
| 1921 | $30,000.00 |
| 1922 | 15,000.00 |
| 1923 | 33,998.75 |
15 B.T.A. 439">*442 The petitioner, on its return for 1920, claimed a deduction on account of personal expenses of $25,811.91. Of this amount $20,172.22 was spent by W. K. Ryan and $399.08 by J. M. Hopkins.
The amount of dividends paid by petitioner during the years 1919 to 1923, inclusive, as shown by the books of the petitioner, was as follows:
| 1919 | $70,000 |
| 1920 | 190,000 |
| 1921 | 190,000 |
| 1922 | 248,125 |
| 1923 | 235,000 |
In 1919 the petitioner's plant was inadequate to take care of the number of orders for the repair of cars. The officers and directors of petitioner decided to expand the plant because the business that had been secured was sufficiently profitable to justify a large expenditure for additional plant. The petitioner built a new plant. Expenditures therefor were made in the amounts of $219,000 in 1919 and $243,000 in 1920. This total expenditure was charged to capital accounts. The type of work to be1929 BTA LEXIS 2852">*2858 done in the new plant made it necessary to build the plant substantially, and it was consequently of a permanent nature.
In 1921 fewer orders for repairs were received. In the summer of 1922 a general strike of railroad shopmen occurred and resulted in the railroads again requiring an unusually large amount of repair work to be done outside of their own shops. Petitioner's gross sales increased from about $2,500,000 in 1921 to approximately $4,500,000 in 1922 and to about $7,500,000 in 1923. This work was not as profitable, however, as the work done in 1920, the net profit in 1923 being approximately $534,000, while the net profit in 1920 was nearly $2,000,000. The petitioner required additional facilities to handle its increased business in 1923, and to take care of this situation it leased a plant during this calendar year. Petitioner has secured no orders for the repair of railroad cars since 1924. Due to this fact a large part of the plant and equipment of the petitioner has not been used since the fall of 1924. In addition the petitioner has since 1924 made less use of a large amount of other physical assets due to lack of sufficient business. The petitioner continued1929 BTA LEXIS 2852">*2859 to use the new plant.
During the year 1922 the petitioner had an appraisal made of its entire plant by an audit company. This appraisal segregates the property items and assigns to each a depreciable value as of that year. The total depreciated value of petitioner's plant as shown by the appraisal is approximately 30 per cent greater than the amount at which it was theretofore carried on the books of petitioner. Prior 15 B.T.A. 439">*443 to this appraisal the physical properties of petitioner had never been set up on the books in detail.
The following is the value, as shown by the appraisal of 1922, of the property which has been in entire disuse since the fall of 1924.
| Door fixture shop | $17,000.00 |
| Car repair shop | 69,915.00 |
| Compressed air piping | 4,916.00 |
| Air compressor equipment | 32,000.00 |
| Miscellaneous rolling equipment | 75,332.00 |
| Wood mill machinery | 40,395.00 |
| Boiler room boilers | 6,500.00 |
| Total | $246,058.00 |
The door fixture shop is a large, one-story, frame structure. It was built in 1900 or 1901. The old plant had been equipped to repair both wooden and steel cars.
The books and records of petitioner do not contain any information as to the cost1929 BTA LEXIS 2852">*2860 or depreciated value of any of its original plant equipment, other than the new plant.
The petitioner did not derive 50 per cent or more of its gross income for the taxable year in question from cost plus Government contracts or from Government contracts made between April 6, 1917, and November 11, 1918.
In computing the invested capital of petitioner for the year 1920, the respondent excluded the amount of $1,500,000 which petitioner had included for good will. He also denied petitioner's claim for special assessment.
OPINION.
SIEFKIN: The petitioner contends that it comes within the provisions of section 327 of the Revenue Act of 1918 and is entitled to have its tax determined as provided in section 328 of that Act.
Section 327 of the Revenue Act of 1918 provides:
That in the following cases the tax shall be determined as provided in section 328:
(a) Where the Commissioner is unable to determine the invested capital as provided in section 326;
(b) In the case of a foreign corporation;
(c) Where a mixed aggregate of tangible property and intangible property has been paid in for stock or for stock and bonds and the Commissioner is unable satisfactorily to determine1929 BTA LEXIS 2852">*2861 the 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 15 B.T.A. 439">*444 tax computed by reference to the respective corporations specified in section 328. This subdivision shall not apply to any case (1) in which the tax (computed without benefit of this section) is high merely because the corporation earned within the taxable year a high rate of profit upon a normal invested capital, nor (2) in which 50 per centum or more of the gross income of the corporation for the taxable year (computed under sections 233 of Title II) consists of gains, profits, commissions, or other income, derived on a cost-plus basis from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both1929 BTA LEXIS 2852">*2862 dates inclusive.
The petitioner claims that there are four abnormalities affecting its capital or income. These contentions will be considered in order.
(1) Petitioner alleges there was an abnormal condition affecting its invested capital caused by failure of respondent to include therein any value for good will.
The evidence discloses that the respondent excluded from petitioner's invested capital an amount of $1,500,000 which petitioner had included for good will. No evidence was introduced by petitioner to directly show that there was a good will. We gather from the record that there was some good will but the petitioner does not attempt to show what it cost or that it is impossible to show the cost. The mere showing that the respondent excluded from invested capital the amount claimed for good will does not prove an abnormality entitling petitioner to special assessment.
In , in denying the petitioner special assessment, we stated:
Petitioner complains of the exclusion of good will from invested capital, but fails to prove either that the good will was paid in for stock or what amount, if any, was expended in1929 BTA LEXIS 2852">*2863 its acquisition or accumulation. (See .)
(2) Petitioner alleges that there was an abnormal condition affecting its income caused by the fact that services of large value in securing business were rendered petitioner by stockholders who were paid no compensation therefor by petitioner and whose expenses in securing said business were not paid by petitioner.
Ryan, president of petitioner, testified that from 80 to 90 per cent of the total orders received by petitioner in 1920 were obtained by three stockholders who owned or controlled about 75 per cent of the stock of petitioner in that year. The total amount of business done by petitioner in 1920 amounted to about $7,500,000, and Ryan testified that the normal cost of obtaining such amount of business would be from $200,000 to $400,000. No salaries were paid the stockholders nor were they reimbursed for any expenses. No evidence was introduced to show the amount of expenses which were incurred by the stockholders in obtaining orders.
We are not convinced that the receipt of orders by the petitioner during 1920 was due in a large measure to the activities of the1929 BTA LEXIS 2852">*2864 stockholders. 15 B.T.A. 439">*445 The evidence shows that there was an enormous amount of repair work on railroad cars to be done in 1920 after the railroads had been returned to private ownership. Apparently the railroads sought out firms which would do the repairs and it was not necessary for such corporations as the petitioner to spend much time or money to secure business. This is evidenced by the testimony of Ryan, which was in part as follows:
* * * So the railroads, then, of course, that we had cultivated and had done some work for, commenced calling on us to undertake unusually large assignments of work, and that was the thing that really led up to our extending our facilities.
* * *
But we always recognized - it was a general understanding in the business that it was not a stable business; it was emergency business, and we all had that feeling when we expanded our plant in 1919 and 1920. We knew that under normal conditions we would never be able to keep it going, but the situation was there, and the people we had done work for said "We have been good customers of yours; we have to have this help, and you must do something to help us out," and there was the prospect of1929 BTA LEXIS 2852">*2865 getting a substantial profit in the work and we went to it.
It will be noted that the petitioner in 1920 did work for only two companies. Petitioner had done work for both of them before and one of them was a customer of several years standing.
We conclude that there was no abnormality in this respect which entitles petitioner to special assessment.
(3) The petitioner contends that there was an abnormal condition affecting its income caused by the fact that its books and records do not contain information from which authorized allowances for obsolescence, deductible from income during 1920, may be computed.
Petitioner contends that a deduction for obsolescence on the plant would have been allowable for the year 1920 but that the books do not show the cost of the old plant, and, since it is impossible to take this deduction an abnormal condition exists.
The evidence discloses that due to the fact that railroads while under Federal control had reached a state of disrepair, after they were returned to private ownership in 1920, there was a large amount of repairing to be done which the railroads could not handle themselves. Due to this condition the petitioner received1929 BTA LEXIS 2852">*2866 orders for a large amount of repair work. Its plant was not sufficient to handle the business and a new plant and equipment were installed at a total cost of $462,000. The old plant of the petitioner had been equipped to handle both steel and wooden cars.
Since the fall of 1924 a part of the plant and equipment of petitioner has not been used at all and a part of it has been used to a lesser extent than before. However, we are not convinced that the 15 B.T.A. 439">*446 petitioner has abandoned the old property. The petitioner in 1922 again had need of all its plant and equipment due to the railroad shopmen's strike and even had to rent an additional plant to take care of the increased business.
The fact that a part of the plant has been in disuse does not necessarily mean that it has been abandoned. As far as the record shows, the petitioner has made no effort to dispose of any part of the plant and equipment and title to it has not been abandoned. The property is not obsolete in the sense that it is out of date. Testimony was introduced to show that there is now no condition existing which would indicate that all of the plant and equipment would ever be needed again. However, 1929 BTA LEXIS 2852">*2867 the business of the petitioner is an emergency business and an emergency might arise at any time. We believe the plant and equipment of petitioner is in disuse simply by reason of a lack of business, and no deduction for obsolescence would be allowable in 1920. It follows that the impossibility of determining the cost of the assets in disuse does not create such an abnormality as is referred to in section 327.
(4) Petitioner contends that there was an abnormal condition affecting its income caused by the fact that the petitioner made large capital expenditures in 1920, which were charged to capital accounts but useful only for the purpose of handling a temporary peak load of business during the year 1920.
Our discussion of the previous contention disposes of this one. The usefulness of the capital expenditures was not confined to the year 1920. Even if it were there would be no abnormality entitling petitioner to special assessment.
In , the petitioner, in order to be in a position to sell its output and supply the demand of an Army cantonment located at Chillicothe, made expenditures of a capital nature in the sum1929 BTA LEXIS 2852">*2868 of $20,000. The petitioner contended that the expenditures for machinery were made necessary because of the war condition, that this machinery was unproductive to a great extent after the cessation of the war activities, and that the apparent extraordinary profits during the year 1918 represent a realization in one year of the earnings of capital unproductively invested or employed through a period of years. We denied special assessment in that case.
The petitioner having failed to show any abnormal condition affecting its invested capital and income for the year 1920, is not entitled to special assessment.
Judgment will be entered for the respondent.
Footnotes
1. Net loss. ↩