*2255 Petitioner held not to be entitled to special assessment for the years 1920 and 1921.
*1098 This proceeding is for the redetermination of alleged deficiencies for the calendar years 1920 and 1921 amounting to $3,725.31 and $2,503.32, respectively. The petitioner alleges that there is no deficiency, but, on the contrary, that there was an overpayment of tax due to the failure of the respondent to properly apply the provisions of sections 326, 327, and 328 of the Revenue Acts of 1918 and 1921 and grant special assessment. The respondent has moved to increase the deficiencies asserted and the parties have stipulated that if the petitioner is not entitled to special assessment for those years the correct deficiencies are $5,406.86 and $3,603.46 for 1920 and 1921, respectively.
FINDINGS OF FACT.
Petitioner is a corporation organized under the laws of the State of Washington, with its principal office and place of business at Tulalip. It*2256 was organized in March, 1912, for the purpose of engaging in the logging business and was capitalized at $10,000, consisting of 100 shares of stock of a par value of $100 per share. The original incorporators and stockholders were H. W. White, T. J. Hartley, and George Miller, who purchased and owned 34, 33, and 33 shares, respectively, paying cash therefor.
During 1912, 1913, and 1914 the petitioner was logging timber adjacent to Lake Washington and toward the close of 1914 it had practically logged out the timber it had been operating on during those years. About 1913 or 1914 the Government invited bids for *1099 the purchase of the timber on the Tulalip Indian Reservation in the State of Washington. H. W. White and other stockholders of the petitioner investigated the timber on the Tulalip Indian Reservation in order to determine whether to enter a bid. The amount of time and money spent in such investigations can not now be determined. The petitioner was never charged anything for the services of the stockholders nor was any stock ever issued to them therefor.
A brother of T. J. Hartley, one Roland H. Hartley, who was not a stockholder of the petitioner at the*2257 time, twice thorougly cruised the timber standing on the Tulalip Reservation in detail. He took with him assistant cruisers or compassmen and prepared blueprints or maps of the timber cruised. The estimates of the number of feet of timber made by Hartley closely approximated the estimates made by the Government. The petitioner did not pay Roland H. Hartley anything for his expenses or for the value of his services and such values are not reflected in petitioner's invested capital. The records of the time and expenses incurred by Roland H. Hartley in cruising the Tulalip timber are not now available and can not be determined.
At a special meeting of the stockholders and trustees of the petitioner held on August 7, 1914, it was resolved that a bid be made for the timber on the Tulalip Indian Reservation at a price not to exceed the sum of $4.10 per thousand feet board measure on an average for all merchantable timber on the reservation. In determining what to bid for the timber the petitioner considered the cost of its prior timber operations, the thicker and better timber on the Tulalip Reservation, deferred payments and the absence of interest thereon and the absence of taxes*2258 on the timber covered by the proposed contract.
Petitioner's bid was accepted and thereafter approximately 70 contracts were executed under the terms of which the petitioner purchased the timber in question from the Indian allottees, the Interior Department executing each contract on behalf of the allottee. These contracts are hereinafter referred to generically as the "Tulalip contract." After petitioner's bid had been accepted, Roland H. Hartley became a stockholder in the petitioner through the purchase of H. W. White's 34 shares of stock for $34,000. He paid $34,000 for the stock because the petitioner had been awarded the contract. The contract prices for the timber per thousand feet were cedar $4.50, fir and spruce $3.87, and hemlock $1. The contract required payment of 10 per cent of the estimated value of the timber sold within 30 days from the date it was approved by the Secretary of the Interior. The Government estimated the total footage to be approximately 350,000,000 feet and expected to receive, altogether, approximately $1,280,000. Consequently, the initial payment provided for under the contract was $128,000.
*1100 After providing for the initial*2259 payment, the contract further provided for payments thereafter in installments of $15,000 to cover various timber allotments as the petitioner cut the same and also provided for an average cut of not less than 25,000,000 feet per year. The cut of the petitioner averaged about 30,000,000 feet yearly and approximately that much was cut in 1920. The total cut of the timber was made between the years 1915 and 1926 and the petitioner actually paid for the timber purchased the amount of $1,318,250.34.
The credit of the petitioner at the time it was awarded the contract was not very large and was inadequate to carry out the terms of the contract. It relied almost entirely on the credit of Roland H. Hartley, who put up everything he had to secure the 10 per cent payment required under the contract. In addition to his own credit, he also employed the credit of his brother to the extent of $30,000 and that of his father-in-law to the extent of $50,000, neither of whom were stockholders in the petitioner. The credit of the other two stockholders was also used by the petitioner. The petitioner did not have capital enough to enable it to put up a bond of $25,000 which was required by the*2260 Government for the faithful completion of the contract and the bond was given by two men who were strangers to the corporation.
The grade of timber on the Tulalip Indian Reservation was much better than anything theretofore logged by the petitioner. Its quality was good, logging conditions were excellent, and there were no main-line transportation charges. It was large timber and nearly twice as much to the acre as that previously operated by the petitioner. Other good and well located timber cost from $4 to $5 a thousand, with about a $3 freight rate against it. Also the petitioner had no fire risk and it was not compelled to pay interest on deferred payments or taxes. The petitioner estimated a saving in interest over the life of the contract in the amount of $306,680.45 and also estimated a saving in tax in the amount of $53,698.77.
The petitioner expected to make exceptional profits from operations when it secured the contract and, due to the topography of the land, its proximity to water transportation, its railroad accommodations, the absence of interest, towage charges, taxes and fire risk, it was estimated that it would make from $1,000,000 to $1,500,000 on the contract. *2261 At the time the contract was secured it had a bonus value variously estimated to be from $300,000 to $500,000 and a value of $279,416.65 based on petitioner's estimated saving in interest and taxes.
The entire capital stock of the petitioner was owned by its three officers in 1920 and 1921. R. H. Hartley was president, T. J. Hartley, secretary and treasurer, and George Miller, vice president and *1101 general manager. R. H. Hartley generally supervised the business in his capacity as president. T. J. Hartley handled the sale of logs cut by the petitioner, and George Miller was in charge of operations. The annual salaries of the officers were as follows: R. H. Hartley, president, $8,160; George Miller, vice president, $10,320; and T. J. Hartley, secretary and treasurer, $9,120. Larger salaries were not paid the officers, due to the fact that they owned all the stock of the petitioner. The officers put in long hours each day and also worked at night if the circumstances required, and their good management of petitioner's affairs contributed to its profits.
The balance sheets taken from the books of the petitioner as at December 31 for the years 1918, 1920, and 1921, *2262 show as follows:
| December 31, | December 31, | December 31, | |
| 1918 | 1920 | 1921 | |
| ASSETS | |||
| CURRENT: | |||
| Inventories | $6,298.43 | $11,273.15 | $5,707.89 |
| Notes and accounts receivable - | |||
| Notes | 292.00 | 5,200.00 | |
| Accounts | 4,824.98 | 11,265.74 | 26,163.64 |
| Cash in bank and on hand | 4,605.19 | 35,845.59 | 36,679.74 |
| United States Treasury Certificates | 39,228.49 | 30,037.80 | |
| FIXED: | |||
| Logging railroad machinery and equipment | 142,549.80 | 147,193.21 | 147,039.86 |
| Right of way | |||
| Woodinville mill | |||
| Timber accounts | |||
| PROSPECTING EXPENSE | 44,110.20 | 29,549.90 | 24,635.70 |
| INDIAN TIMBER CONTRACT: | |||
| Advance accounts | 83,536.12 | 62,198.17 | 37,416.85 |
| STOCKS OF OTHER CORPORATIONS | 1,250.00 | ||
| DEFERRED | 250.00 | ||
| 326,945.21 | 327,363.56 | 282,843.68 | |
| LIABILITIES | |||
| CURRENT: | |||
| Notes and accounts payable - | |||
| Notes | |||
| Accounts | 7,312.02 | 8,836.95 | 15,966.40 |
| Accruals | |||
| RESERVE FOR DEPRECIATION | 48,643.13 | 85,065.82 | 97,416.71 |
| CAPITAL AND SURPLUS: | |||
| Capital stock - | |||
| Authorized issue - fully paid | 10,000.00 | 10,000.00 | 10,000.00 |
| Surplus | 260,990.06 | 223,910.79 | 159,460.57 |
| 326,945.21 | 327,363.56 | 282,843.68 |
It was stipulated that, in the absence of special assessment, the petitioner's net income, invested*2263 capital, tax liability, and deficiency in tax for each of the years 1920 and 1921 were as follows:
| 1920 | 1921 | |
| Net income | $165,877.14 | $42,894.79 |
| Invested capital | 129,964.85 | 160,937.81 |
| Tax liability | 69,013.30 | 10,969.28 |
| Deficiency in tax | 5,406.86 | 3,603.46 |
No part of the gross income of the petitioner for the years 1920 and 1921 was derived on a cost-plus basis from a Government contract *1102 or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.
OPINION.
SMITH: On motion of the respondent, and by stipulation entered into between the parties, the hearing of this proceeding was limited to a single issue, namely, the right of the petitioner to special assessment under the provisions of sections 327(a) and 327(d) of the Revenue Acts of 1918 and 1921, which read as follows:
(a) Where the Commissioner is unable to determine the invested capital as provided in section 326;
* * *
(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, *2264 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 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 section 233 of Title II) consists of gains, profits, commissions, or other income, derived on a costplus basis from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.
It was further stipulated that in the absence of special assessment there are deficiencies in petitioner's taxes for the years 1920 and 1921 amounting to $5,406.86 and $3,603.46, respectively.
The petitioner contends that abnormalities in invested capital and in income, as contemplated by the Revenue Acts of 1918 and 1921, existed in its case and that the respondent is unable to determine*2265 accurately its invested capital. Counsel for petitioner on brief summarizes the points relied upon in support of such contentions and states that:
On the present record it is submitted that the Board should hold that the petitioner is entitled to a comparative assessment for the years 1920 and 1921 because -
(a) The Tulalip contract, which was the chief source of petitioner's income for 1920 and 1921, had a large bonus value on acquisition which is entirely excluded from petitioner's statutory invested capital:
(b) The Tulalip contract caused abnormalities in petitioner's income for 1920 and 1921 - on account of no deduction for interest and taxes and substantial saving in freight, which items usually enter into cost of production:
(c) The credit of petitioner's stockholders and their friends was contributed to the company and used in securing and carrying out the Tulalip contract:
*1103 (d) Petitioner paid inadequate and low salaries to its officers for the valuable services rendered, said officers being its sole stockholders:
which facts constitute abnormal conditions affecting the capital and income of petitioner for the years 1920 and 1921 within the meaning*2266 of Section 327(d), Revenue Acts of 1918 and 1921.
Petitioner is also entitled to comparative assessment for said years because its stockholders contributed substantial financial and cruising services to it as paid in surplus, the amount of which, because of lack of records, can not now accurately be determined, thereby bringing the petitioner's case within the provisions of subdivision (a) of Section 327, Revenue Acts of 1918 and 1921.
With respect to petitioner's contention relative to the bonus value of the Tulalip contract, it must be conceded that such contract had a very large value after it was secured by the petitioner. However, it should be borne in mind that the contract cost the petitioner nothing. The contract was for the purchase of timber and the amounts paid out by the petitioner under its terms constituted the purchase price of the timber which was sold later at a profit. Accordingly, we are of the opinion that the profits made by the petitioner during the taxable years under review were derived from the sale of the timber purchased under the contract and that they did not directly flow from the contract. We can see no difference between the petitioner's situation*2267 and that of any other taxpayer who is fortunate enough to be able to buy a quantity of goods at a low price and sell at a large profit. We do not believe that there existed any abnormalities in petitioner's income by reason of the contract in question, especially in view of the provisions of sections 327(d) of the Revenue Acts of 1918 and 1921, which specifically state that the earning of large profits does not in itself constitute a reason for special assessment.
Neither are we convinced that an abnormality existed in petitioner's income due to the fact that it was not required to pay interest on deferred payments or taxes on account of the timber purchased or because of a substantial freight differential existing in its favor. While it is true that moneys expended under items such as those enumerated constitute deductions from gross income and thus tend to reduce the amount of taxes otherwise payable, we are of the opinion that the advantages enjoyed by the petitioner with respect to such items were fortuitous and did not create an abnormality in income within the meaning of the statute. Petitioner is in no different position from that of any taxpayer who might set up a business*2268 where the market for its product was in close proximity to the source of raw material, where the State in which the business was located had a low tax rate, and where it was enabled to obtain credit at favorable interest rates.
The mere fact that the petitioner began its operations on borrowed capital through the extension of credit to it by its stockholders and *1104 their friends does not, in our opinion, constitute such an abnormality as would entitle it to special assessment. Especially is this true in view of the fact that a comparative balance sheet of the petitioner showing its assets and liabilities for each year from 1912 to 1921, both inclusive, which was introduced in evidence, discloses that notes payable had disappeared from the liability side as early as December 31, 1918, and that its current liabilities for years ended December 31, 1920, and December 31, 1921, were represented by accounts payable in the amounts of $8,386.95 and $15,966.40, respectively. Even should it be conceded for purposes of argument that the credit extended to the petitioner at the beginning of its operations constituted an abnormality in invested capital, such condition had ceased*2269 to exist long prior to the taxable years under review.
Petitioner further claims, however, that it paid low and inadequate salaries to its officers for the valuable services rendered and that by reason thereof its deductions from gross income compared to those allowed others employed in the same line of business placed it at a disadvantage. Passing the question as to whether such disadvantage to the petitioner would constitute an exceptional hardship, we are not impressed by the evidence before us that the salaries paid its officers were inadequate. T. J. Hartley, secretary and treasurer of the petitioner from its formation in 1912, testified that the salaries paid petitioner's officers in 1920 and 1921 constituted reasonable compensation and that such salaries compared favorably with the salaries paid by other companies. In view of such testimony we can not concede this point.
The last point relied upon by the petitioner is that the value of services rendered the petitioner by officers and stockholders in cruising the timber purchased in the Tulalip contract constituted paid-in surplus, the amount of which, because of lack of records, can not now accurately be determined, *2270 and that therefore the respondent is unable to correctly determine the petitioner's invested capital. The evidence on this point indicates that George Miller and H. W. White, who were officers and stockholders of the petitioner prior to the acquisition of the Tulalip contract, looked over the ground generally, but did not make an intensive or close study of the timber which the petitioner contemplated purchasing. In view of such fact, we are convinced that the services rendered the petitioner by such officers and stockholders were no more than could be expected in the furtherance of corporate activities and that the petitioner had the benefit of no more than the usual and ordinary activities which it had a right to expect from its officers and for which it paid them a salary.
With respect to the activities of Roland H. Hartley, it must be conceded that he did make an intensive and thorough cruise of the *1105 timber purchased and it is only reasonable to assume that in making such cruise he expended a substantial amount of money. Roland H. Hartley, however, was neither an officer nor a stockholder of the petitioner at the time he made the survey and cruise of the timber*2271 and it is significant to note that he became a stockholder and paid for the stock which he purchased 10 times its par value, due solely to the fact that the petitioner's bid for the Tulalip timber had been accepted. In this view of the situation it is unescapable that his activities were conducted primarily for his own interest, with a view of determining whether he should later purchase an interest in the petitioner. It may be assumed, perhaps, that the petitioner derived some incidental benefit from the activities of Roland H. Hartley in planning its operations after it had acquired the contract in question, although there is no evidence before us on this point. We are of the opinion therefore that the respondent is not unable to determine invested capital by reason of the activities of Miller, White, and Hartley, in surveying and cruising the timber prior to the making of the bid therefor.
The petitioner also contends that, if none of the points relied upon, standing alone, might be sufficient to bring it within the terms of the statute and constitute a basis for special assessment, all of them taken together indicate such abnormalities as would work an exceptional hardship*2272 upon the petitioner if it were not assessed upon a comparative basis. Our view, however, is that the petitioner carried on its business enterprise under extremely fortuitous circumstances, deriving from its operations a high rate of profit in each year. Such circumstances, we feel, fall far short of constituting abnormalities in income or invested capital which would work an exceptional hardship upon the petitioner and we are of the opinion that it is not entitled to special assessment for the years under review.
Judgment will be entered for the respondent for $5,406.86 for 1920, and $3,603.46 for 1921.