*3687 1. In 1917 a copartnership purchased certain intangible assets for $161,526 and certain tangible assets for $13,474. In 1918 a corporation was formed with an authorized capital stock of $175,000, and all the assets of the partnership were transferred to the corporation in exchange for its entire capital stock. Thereafter, the corporation conducted the business formerly conducted by the partnership, the members of which remained in control of the corporation. The Commissioner, in computing petitioner's invested capital for the years 1920 and 1921, applied the limitation provided by section 326(a)(5) of the Revenue Acts of 1918 and 1921 to intangibles acquired for stock and determined that intangibles in the amount of $43,750, or 25 per cent of the outstanding capital stock, should be included in invested capital for the years in question. Held, that the Commissioner's action must be approved.
2. Under the circumstances herein, petitioner has established its right under section 327 of the Revenue Acts of 1918 and 1921 to have its profits tax computed under section 328 of those Acts.
*914 This proceeding is for the redetermination of deficiencies in income and profits tax for the calendar years 1920 and 1921, in the amounts of $5,336.89 and $3,141.31, respectively. The petitioner alleges that, in determining the deficiencies, the Commissioner erred in computing its invested capital for the years in question by applying the provisions of section 326(a)(5) of the 1918 and 1921 Acts to the intangible assets which it acquired in 1918, thereby excluding from invested capital the value of the intangibles in excess of 25 per cent of the par value of the total stock outstanding at the beginning of the taxable year. It is further alleged that the Commissioner erred in *915 refusing to apply the provisions of section 331 of the 1918 and 1921 Acts to the assets acquired by it in 1918 from a predecessor partnership, which section, it is urged, permits the inclusion in invested capital of the intangible assets at the cost to the partnership. As an alternative assignment of error, petitioner alleges that, if the Commissioner's action in applying section 326(a)(5) of the 1918 and 1921 Acts to*3689 intangible assets was proper, its profits tax for the years in question should be computed under section 328 of those Acts.
FINDINGS OF FACT.
The petitioner, J. H. Guild Co., Inc., is a corporation organized under the laws of the State of Vermont on or about April 1, 1918, and has its principal place of business at Rupert, Vt. It is and was during the years in question engaged in the manufacture of Guild's Green Mountain Asthma Remedy.
For many years prior to January 25, 1917, the medicine, Guild's Green Mountain Asthma Remedy, had been manufactured by a partnership, styled J. H. Guild Co. The members of this partnership were relatives and during the course of time a quarrel among the partners developed. As a result thereof, a receiver for the business was appointed by the Court of Chancery, Bennington County, Vt. Acting under authority of this court, the receiver on January 25, 1917, sold the business to a new partnership for $175,000 in cash and notes. The new partnership retained the name of J. H. Guild Co. and thereafter conducted the business until April 12, 1918, or thereabout.
The sale of the business to the new partnership on January 25, 1917, was made through*3690 the medium of Myron F. Roberts, the receiver, to whom the various members of the new partnership paid their share in cash or in notes, the cash amounting to $112,000 and the balance of the sum of $63,000 being notes of three of the members of the new partnership who had been members of the old partnership which conducted the business and whose notes were liquidated through the distribution of their interest by the receiver following the sale. The substance of the transaction was that $175,000 in cash or its equivalent was paid by a group of individuals, composing the new partnership, for the business of J. H. Guild Co. To each of the contributing parties the receiver issued a receipt for the share contributed.
The assets, tangible and intangible, of the J. H. Guild Co. acquired on January 25, 1917, for $175,000 by the new partnership consisted of and had values on that date, as follows:
| Accounts receivable | $5,380 |
| Inventory of merchandise | 4,900 |
| Inventory of supplies | 1,725 |
| Furniture and fixtures | 413 |
| Machinery and equipment | 1,056 |
| Good will, formulae and trade-mark | 161,526 |
| 175,000 |
*916 Prior to the purchase of the business by the new partnership*3691 on January 25, 1917, the members discussed the question as to whether a corporation should be organized for the purpose of operating and conducting the business. Some of the members were opposed to incorporating the business and the subject was kept under consideration and discussion until the early part of 1918 at which time it was definitely decided to incorporate. On or about April 1, 1918, the necessary papers of incorporation were filed and shortly thereafter J. H. Guild Co., Inc., was organized. During the period from January 25, 1917, until the time the assets of the new partnership were transferred to the corporation, on or about April 12, 1918, the business of J. H. Guild Co. was continued without interruption. During this time the new partnership, doing business under a firm name, was required by law to make and did make a report to the Secretary of State of the State of Vermont.
By a writing dated January 1, 1918, the persons composing the partnership of J. H. Guild Co. made an offer to J. H. Guild Co., Inc., petitioner herein, to sell to it all of its assets, tangible and intangible. The petitioner, in the meantime having been incorporated and being in a position*3692 to transact business, accepted the offer as made. On or about April 12, 1918, all of the assets of the J. H. Guild Co., a partnership, were transferred to the J. H. Guild Co., Inc., petitioner herein, in consideration of 1,750 shares of its capital stock, each of the par value of $100.
The members of the predecessor partnership, upon proper legal transfer and conveyance of the partnership assets, surrendered to the corporation the receipts obtained from the receiver at the sale of January 25, 1917, and received in exchange therefor capital stock in the amount of the receipt.
In its returns for the years 1920 and 1921, petitioner included in its invested capital the amount of $160,560 as representing the value of the intangibles acquired, under the circumstances and conditions above described, for stock. Upon audit of the returns, the Commissioner determined that the inclusion of intangible assets in invested capital was subject to the provisions of section 326(a)(5) of the Revenue Acts of 1918 and 1921. Accordingly, he further determined that petitioner could include the intangibles in invested capital for the years in question in the amount of $43,750, or 25 *917 *3693 per cent of the total par value of stock outstanding at the beginning of the taxable year.
For the year 1920, the Commissioner, after making certain adjustments, determined that petitioner's net income was $29,262.33 and its invested capital was $58,924.91. For the year 1921, he determined that net income amounted to $24,824.25 and that the invested capital for the year was $60,882.48.
OPINION.
LOVE: The petitioner's first contention is that the Commissioner erred in determining that the intangibles, having a value of more than $160,000, acquired by it in April, 1918, under the circumstances and conditions set forth in the findings of fact, may be included in invested capital for the years in question only to the extent permitted by section 326(a)(5) of the Acts of 1918 and 1921, 1 which, with respect to petitioner, limits the amount to $43,750 or 25 per cent of the par value of the total stock outstanding at the beginning of the taxable year 1918.
*3694 In support of this contention the petitioner takes the position (1) that J. H. Guild Co., the partnership in existence from January 25, 1917, to April 12, 1918, or thereabout, was merely a device to carry on the business, having acquired the assets for the sum of $175,000 which, it held, pending the organization of the corporation, J. H. Guild Co., Inc., petitioner herein, and (2) that the surrender of the receiver's receipts which were given to the members of the predecessor partnership for amounts paid in at the time of acquisition of the business to the corporation in exchange for stock amounted to the payment of cash for the stock and, consequently, the full amount thereof should be included in invested capital pursuant to the provisions of section 326(a)(1) of the 1918 and 1921 Acts. 2
The first point, that the partnership was merely a device to carry on the business until incorporated, seems, in our opinion, to be immaterial and, even if conceded to be true, *3695 has no bearing on the question presented.
*918 Assuming that the members of the partnership intended to incorporate (a fact which, in our opinion, the record does not bear out) we are unable to say that that intent makes it necessary to consider the partnership and the corporation as one and the same, a theory advanced by petitioner in urging that the partnership was only an intermediate step. It is clear that the business conducted by the partnership was entirely separate and distinct from that conducted by the corporation. The corporate entity stands by itself, having come into existence on or about April 1, 1918, and there are no special circumstances whereby the intention of the members of the partnership to incorporate can be imputed to the corporation in such a manner as to make the acts of the partners the acts of the corporation. Obviously, therefore, it can not be said that the purchase for cash of the assets, tangible and intangible, of the J. H. Guild Co. by the partnership on January 25, 1917, constituted a purchase of the same assets for cash by the corporation. There are other apparent fallacies connected with such reasoning which we do not deem necessary*3696 to point out.
The second point, that the surrender to the corporation of the receiver's receipts by the members of the predecessor partnership in exchange for stock amounted to payment of cash for stock, is not, in our opinion, tenable.
In that first place, it is obvious that the receipts were not cash and did not purport to represent cash. Quite the contrary, the receipts were merely evidence that the respective amounts had been contributed to the purchase of the assets by the partnership and, at most, they constituted evidence of the holder's distributive share in the partnership assets. Consequently, for this reason, if for no other reason, the surrender thereof to the corporation did not constitute a cash payment for stock.
However, it might be well to point out that, in taking the position under consideration, the petitioner presupposes that the corporation would, after the surrender of the receipts, have purchased the assets with those receipts, which it contends represented cash. The record warrants no such supposition or assumption. In fact, such procedure was not followed. The partnership, by proper legal form, with its members as subscribers thereto, conveyed*3697 the assets to the corporation prior to the surrender of the receipts. Thereafter, the partnership having no assets, the subsequent surrender of the receipts was a useless and needless formality.
The petitioner having acquired the assets in question in exchange for stock, the provisions of section 326(a)(5) of the 1918 and 1921 Acts clearly apply unless, as alleged in its petition, the provisions *919 of section 331 3 of the Revenue Acts of 1918 and 1921 permit the inclusion of the assets at the cost to the predecessor.
*3698 The petitioner in its allegations of error alleges, among other things, that, having acquired the assets in question from a predecessor partnership, the provisions of section 331 of the Revenue Acts of 1918 and 1921, supra, permit the inclusion of those assets in invested capital at the cost of acquisition to the partnership. In its brief, petitioner did not refer to or discuss this allegation of error. The Commissioner, however, discusses the contention at some length. He denies that, by reason of section 331 of the Acts of 1918 and 1921, the petitioner is entitled to include the intangible assets in invested capital at the cost to the partnership, which was $161,526. On this point we agree with the Commissioner.
The record discloses that an interest or control of 50 per cent or more remained in the same persons formerly conducting the business of J. H. Guild Co., a partnership. Clearly, therefore, petitioner comes within the provisions of section 331 of the 1918 and 1921 Acts.
This section of the two Acts provides a method of determining the value of assets transferred or received from a previous owner in the reorganization, consolidation or change of ownership of*3699 a trade or business, or a change of ownership of property after March 3, 1917. The purpose of the section was to prevent the inclusion in invested capital of unrealized appreciation of assets. It established a maximum invested capital in such cases, and not a minimum. Section 331 of the 1918 and 1921 Acts does not, in our opinion, nullify or amplify section 326(a)(5) of the same Acts. Where section 331 applies to the transfer of intangible assets from a previous owner, not a corporation, to a corporation, the value of the intangible assets transferred may be taken at their cost to the previous owner at the time acquired, with proper allowance for depreciation, impairment, betterment or development. However, such value, in determining the amount thereof that may be used for invested capital purposes, must be applied in accordance with the provisions of section 326(a)(5) of the respective Acts. Thus, it seems clear, that while section 331 of the 1918 and 1921 Acts does not nullify or amplify section 326*920 (a)(5) of the same Acts, an amount otherwise includable in invested capital under the provisions of section 331 may be limited by section 326(a)(5).
We, therefore, *3700 approve the Commissioner's action taken with respect to petitioner's invested capital for the years in question.
As an alternative assignment of error, petitioner alleges that if the Commissioner's action in applying to its intangibles section 326(a)(5) of the 1918 and 1921 Acts is approved, then it is entitled to have its profits taxes for the years in question computed under section 328 of the Revenue Acts of 1918 and 1921.
Petitioner was using in its business intangible assets having a value of more than $160,000 which, because of the manner of its organization, can be included in its invested capital for 1920 and 1921 only to the extent of $43,750. It is urged that by reason of the exclusion of this large amount of valuable intangible assets an abnormal condition affecting its capital arises within the meaning of section 327 of the Revenue Acts of 1918 and 1921. 4
*3701 The Commissioner takes the position that the application of section 326(a)(5) of the pertinent Acts to the intangible assets acquired by petitioner can not produce an abnormality contemplated by the statute and in this respect he relies on the Board's decision in , where we stated:
The corporation was the result of a reorganization of a business carried on prior to its organization, and, under section 331 of the statute, the invested capital is no greater than that of the partnership. The good will was something which had grown with the business, and not something which the owners had ventured in the enterprise. Since it was not paid for or invested, it was not a factor in determining excess profits. Thus it was purposely excluded from invested capital, and its exclusion must be regarded as the normal application of the statute. It can not be consistently said that the statute excludes the item from invested capital and at the same time treats such exclusion as so abnormal as to be the ground for relief by special assessment.
It will be observed, however, that, in the instant case, the amount of intangible assets excluded was of*3702 recognized and substantial value. *921 The intangibles were purchased in a bona fide sale for $161,526 and as such represented an investment in the business. In an enterprise similar to petitioner's, which, by the proper method and form of organization, is able to include in invested capital intangibles purchased for cash, a fair return thereon is a factor in determining the excess-profits tax. But, the petitioner, merely by reason of corporate organization, is precluded from including a large amount of valuable intangibles in its invested capital although such intangibles represent a bona fide investment in the business. The intangibles excluded, both in amount and in comparison with other assets used in producing income, are very substantial. We believe, therefore, that petitioner has established that an abnormal condition affecting capital, as provided in section 327 of the 1918 and 1921 Acts, supra, existed during the years in question.
Accordingly, the petitioner is entitled to a comparison with representative concerns for the purpose of determining whether such a comparison will result in any relief. *3703 ; .
Reviewed by the Board.
Further proceedings will be had under Rule 62.
Footnotes
1. SEC. 326. (a) That as used in this title the term "invested capital" for any year means (except as provided in subdivisions (b) and (c) of this section):
* * *
(5) Intangible property bona fide paid in for stock or shares on or after March 3, 1917, in an amount not exceeding (a) the actual cash value of such property at the time paid in, (b) the par value of the stock or shares issued therefor, or (c) in the aggregate 25 per centum of the par value of the total stock or shares of the corporation outstanding at the beginning of the taxable year, whichever is lowest: Provided,↩ That in no case shall the total amount included under paragraphs (4) and (5) exceed in the aggregate 25 per centum of the par value of the total stock or shares of the corporation outstanding at the beginning of the taxable year; * * *
2. SEC. 326. (a) That as used in this title the term "invested capital" for any year means (except as provided in subdivisions (b) and (c) of this section):
(1) Actual cash bona fide paid in for stock or shares. ↩
3. SEC. 331. 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: Provided,↩ That if such previous owner was not a corporation, then the value of any asset so transferred or received shall be taken at its cost of acquisition (at the date when acquired by such previous owner) with proper allowance for depreciation, impairment, betterment or development, but no addition to the original cost shall be made for any charge or expenditure deducted as expense or otherwise on or after March 1, 1913, in computing the net income of such previous owner for purposes of taxation.
4. SEC. 327. That in the following cases the tax shall be determined as provided in section 328:
* * *
(d) Where upon application by the corporation the Commissioner finds and so declares of record that the tax as 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 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 cost-plus basis from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive. ↩