1936 BTA LEXIS 728">*728 No part of sums expended in a campaign conducted to retain old customers and obtain new ones may be deducted as an ordinary and necessary business expense in the absence of proof of the portion allocable to capital and the maintenance of current business.
34 B.T.A. 228">*228 In this proceeding the petitioner seeks the redetermination of a deficiency of $21,646.67 in income tax for 1930. The issues are whether there should be allowed as ordinary and necessary business expenses compensation paid to solicitors and the cost of installing service lines without charge to consumers.
FINDINGS OF FACT.
For many years prior to 1930 the Houston Gas & Fuel Co., hereinafter referred to as the Fuel Co., sold, first artificial gas and afterwards natural gas, to the inhabitants of Houston, Texas, and vicinity. Until the Houston Natural Gas Co., an affiliate of the petitioner organized in 1925, hereinafter referred to as the Gas Co., entered the field, it had a complete monopoly of the gas business in Houston, a city having a population of about1936 BTA LEXIS 728">*729 139,000 in 1920 and 292,000 in 1930.
By December 1925 the Gas Co. had installed a distributing system in the suburbs of Houston and was selling natural gas at such places in competition with the Fuel Co. In July 1927 the city of Houston granted a franchise to the Gas Co. to distribute natural gas within its borders. Due to the opposition of the Fuel Co., which had contested the issuance of the franchise, the officials of Houston having charge of the matter declined to issue permits to the Gas Co. for the 34 B.T.A. 228">*229 construction of gas mains under the franchise, with the result that the Gas Co. was unable to serve consumers in Houston who had signed applications for gas service. The controversy between the Fuel Co. and the Gas Co. received much local newspaper publicity and was the primary issue in a city election held in December 1928. The voting resulted in the election of a new mayor of the city and within a short time the Gas Co. obtained construction permits, and thereafter began paralleling the lines of the Fuel Co. within the city limits of Houston. Thereafter the Fuel Co. and the Gas Co. served Houston and vicinity with natural gas under competitive conditions. They1936 BTA LEXIS 728">*730 charged the same rates for domestic gas, except that the price of the Fuel Co. carried a penalty of 10 percent if the bill was not paid within 10 days after being rendered.
In an effort to prevent the Gas Co. from getting established in business in Houston, the Fuel Co. doubled its soliciting force, and thereafter, as the distributing system of the Gas Co. increased in the area, it engaged more solicitors to meet the additional competition. To offset the effect of their efforts, the Gas Co. employed a similar number of solicitors. In 1929 each company had from 35 to 40 solicitors in its employ and in 1930 the number ranged from 40 to 50.
The work of solicitors of the Gas Co. in 1928 was confined to the suburbs of Houston. In 1929 its agents were soliciting customers in practically all sections of Houston. The Gas Co. inaugurated its campaign for customers in Houston in May 1929.
By the close of 1929 the Gas Co. had completed a distribution system and was serving consumers in most of the outlying sections of Houston and in several thickly populated sections nearer the center of the city. The distributing system was extended into new sections of the city whenever applications1936 BTA LEXIS 728">*731 for gas service justified the extension.
It is stipulated that the duties and activities of the solicitors of each company were:
* * * to keep informed concerning prospective new consumers, to try and sell gas service to the same, cultivate and maintain good will of old consumers as well as prospective new consumers, prevent their company's consumers from switching to the competing company, persuade the competing company's consumers to become consumers of their company, combat similar activities of the competing company's solicitors, and otherwise to support and increase the volume and profitableness of their company's business. * * *
The Gas Co. could not have met the competition of the Fuel Co. as well as it did without the efforts of its solicitors. The employment of solicitors to increase business, develop and maintain good will and sell gas appliances is a common practice of gas companies.
34 B.T.A. 228">*230 In November 1928 the Gas Co. sold its properties in practically all areas except Houston and its suburbs and Pasadena, Texas.
The book value of the physical properties and the number of employees and customers of the Gas Co. as of the close of 1926 to 1930, inclusive, 1936 BTA LEXIS 728">*732 and its pay roll and gross sales during such years were as follows:
| 1926 | 1927 | 1 1928 | 1929 | 1930 | |
| Physical properties | $647,111 | $1,390,015 | $2,647,408 | $2,731,999 | $3,483,926 |
| Number of customers: | |||||
| Outside Houston | 832 | 2,768 | 6,579 | 1,761 | 2,057 |
| Within Houston | 450 | 1,485 | 8,729 | 13,903 | |
| Number of employees | 475 | 566 | 469 | 355 | |
| Pay roll | $111,621 | $212,568 | $327,182 | $464,293 | $471,027 |
| Gross sales | 31,492 | 255,844 | 769,231 | 846,605 | 1,081,006 |
In 1929 and 1930 the Gas Co. expended $42,353.16 and $69,156.15, respectively, in payment of salaries and expenses of its solicitors. It has made no allocation of the amounts on the books between the acquisition of new and the retention of the old customers. The amounts were charged to an account termed "property Account." The Gas Co. deducted depreciation thereon on its books in subsequent years, but it has never made a claim for exhaustion of the item in income tax returns. The amounts were claimed as ordinary and necessary business expenses in returns filed for the respective years. The respondent did not disallow the deduction made in the 1929 return, but disallowed the1936 BTA LEXIS 728">*733 claim made in the 1930 return.
In all parts of Houston in which they had parallel lines during 1929 and 1930 the Fuel Co. and the Gas Co. installed service lines on premises of consumers free of cost to the consumer. Such a policy is followed by gas companies only when local conditions justify the action. The Fuel Co. initiated the practice in Houston in the latter part of 1928 or the early part of 1929. Whenever the Gas Co. consented to install a service line free of charge to the consumer, the application signed by the consumer for the installation contained the words "No charge" written over the provisions of the application from providing for a charge for the installation. Such action on the part of the Gas Co. was necessary to meet the competition of the Fuel Co. Such application, together with the form executed by the consumer for gas, constituted the written contract between the parties on the subject. Service lines were not installed free of charge by either company in sections of the city in which they did not compete for business.
During 1929 and 1930 the Gas Co. expended $97,580.17 and $111,232.75, respectively, in payment of the cost of installing service lines1936 BTA LEXIS 728">*734 free of charge to consumers. Of such service lines installed 34 B.T.A. 228">*231 in 1930, service lines costing $33,831.60, $34,968.48, and $11,248.28 were disconnected during the years 1930, 1931, and 1932, respectively, but an undetermined number were later reconnected in those years.
The amount expended in 1930 for installing service lines free of charge to the consumers was charged to an account termed "Property Account" on the books of the Gas Co. It deducted depreciation thereon on its books in 1930 and subsequent years, but it has never claimed a deduction for depreciation on the property in any of its income tax returns. The respective amounts were claimed as ordinary and necessary business expenses in 1929 and 1930. The respondent did not disallow the claim made in 1929, but he disallowed the deduction of $111,232.75 claimed in 1930.
OPINION.
SEAWELL: The respondent questions the deductibility of the amounts in question as ordinary and necessary business expenses on the ground that the expenditures were made in the acquisition of a capital asset. He regards the proceedings as being analogous to the creation or enlargement of the circulation structure of a newspaper or1936 BTA LEXIS 728">*735 magazine.
No authority need be cited for the long established rule that expenditures made for benefits which are to be enjoyed for a period extending beyond the year in which they are made should be capitalized and, if of an exhaustible nature, exhausted ratably over the useful life of the asset, and may not be deducted from income as ordinary and necessary business expenses.
Expenditures made to maintain the circulation structure of a newspaper or magazine are ordinary and necessary business expenses, but those made for the primary purpose of increasing it are not. ; ; affd., ; ; affirmed on this point, ; ; affd., ; certiorari denied, . The principal of these cases applies equally to other lines of business. In 1936 BTA LEXIS 728">*736 , the cost of developing a foreign market for mechanics' tools, charged to expense when incurred, was restored to surplus and included in invested capital. The cost of increasing an insurance policy list was held in , to be a capital expenditure. Amounts expended for novelty banks distributed, among other things, to obtain new depositors were disallowed as a business expense in (reversed on 34 B.T.A. 228">*232 other issues, ), on the ground that the expenditures created benefits extending into future years. In , sums paid to an individual to persuade depositors to transfer their accounts and to solicit new ones were held to be capital expenditures. In , sums were expended for agents' salaries, advertising, samples, etc., in connection with a campaign conducted in new sales territory. In holding that some part of the expenditures resulted in the acquisition of a capital asset, it was said:
1936 BTA LEXIS 728">*737 There can be little doubt in the minds of reasonable men fairly acquainted with modern business that promotion expenditures like those before us have a significance similar to the investment in more tangible assets. They fertilize the field for new production. The free distribution of samples at the state fair is justified only if it lures a new customer. It was not to the housewife already convinced that the petitioner planned to give away its samples of yeast year after year, but to one who would become a new unit in its expanding business. In this way it was risking new capital in the business in the hope of future profits - making an investment. Whether this investment is to be called good will or trade name or trademark, or something else, is unimportant. It may not need a name, except for accounting purposesIn order to reflect the expenditure and yet not ignore its investment significance.
, is to the same effect.
The petitioner contends that the cases cited are not controlling, on the ground that it had passed out of its organization or promotion stage prior to the taxable year and that the expenses of the solicitors1936 BTA LEXIS 728">*738 and the cost of laying the service lines were outlays made to protect and maintain an established business. The rule governing the question before us makes no such distinction.
In , the expenditures were made over a period of 15 years after the corporation was organized, and under the sales promotion plan new territory was canvassed each year. The expenditures involved in , were made at least five years after the institution came into existence. In other cases the expenses were incurred long after the taxpayers were organized. ;;
In order to hold that the whole of the amounts involved was expended by the Gas Co. for the sole purpose of maintaining its list of customers and that the increase in business was only incidental to the activities carried on, we would have to disregard evidence clearly establishing the contrary.
As early as 1928 it had applications for gas service from residents of Houston, but until May 1929 it was not1936 BTA LEXIS 728">*739 in a position to supply such demand. The increase of customers in 1929 was about 600 percent and in 1930 the number of its consumers increased about 34 B.T.A. 228">*233 60 percent. This additional volume of trade represents new business in territory just entered and resulted, in part, from the efforts of the soliciting agents and the laying of service lines for consumers free of charge in a campaign for new consumers inaugurated in 1929.
The record abounds with testimony relating to the keenness of the competition between the gas companies in 1929 and 1930, including extreme methods used by the Fuel Co. in an effort to prevent the Gas Co. from establishing a profitable business in territory in which it had for many years enjoyed a monopoly. The success of the Gas Co. in Houston depended not only upon its ability to retain what it had in the way of customers, but to obtain new business. The countervailing tactics employed by it were designed to and did accomplish both purposes. The new business may not be regarded as an incidental result of the expenditures.
The Gas Co. made no allocation of the expenditures on its books between the acquisition of new business and the maintenance1936 BTA LEXIS 728">*740 of old consumers and there is no testimony in the record on the point. Without means of determining to what extent the total expenditures are properly chargeable against current income, we are obliged to and do sustain the action of the respondent in disallowing the whole amount as an ordinary and necessary business expense.
Decision will be entered for the respondent.
Footnotes
1. Prior to sale. ↩