West Florida Naval Stores Co. v. Commissioner

*802 This proceeding is for the redetermination of deficiencies in income and profits tax for the calendar years 1918 and 1919 in the amounts of $10,222.57 and $13,890.37, respectively. The petitioners are affiliated corporations and made one consolidated return for each of the taxable years. They allege that the Commissioner erred in computing the deficiencies in that he refused to grant relief under section 328 of the Revenue Act of 1918.

FINDINGS OF FACT.

The West Florida Naval Stores Co. is the successor of the Pensacola Grocery Co. In 1911 the stockholders of the Pensacola Grocery Co. devised a plan of business for the organization of a *803 corporation which would sell groceries to producers of turpentine and rosin and act as a factor in selling such naval stores produced by them on a commission basis. With this plan in view, the*2515 stockholders approached the producers of naval stores and entered into agreements with them by which they agreed to acquire stock of the new corporation, purchase groceries from such corporation, and sell naval stores produced by them. The corporation to be formed was also to advance them money to aid in the conduct of the naval stores operations. It was agreed that the new corporation should acquire the tangible assets of the Pensacola Grocery Co. at their fair inventory value. The West Florida Naval Stores Co. was incorporated on or about September 3, 1911, and, pursuant to the arrangements already made, acquired the assets of the Pensacola Grocery Co. at their inventory value. The assets were appraised by a committee appointed by the West Florida Naval Stores Co. for that purpose. The classes of assets purchased and the price paid for them were as follows:

The Pensacola Grocery Co. had a capital stock of $50,000 in 1906, and of $51,000 in 1907, 1908, 1909, and 1910. The net profits, capital and surplus*2516 and bills payable of the Pensacola Grocery Co. for the years 1906 to 1910, inclusive, were as follows:

The incorporators then organized the West Florida Grocery Co. with a capital stock of $100,000 to operate the grocery department of its business. All of this capital stock was owned by the West Florida Naval Stores Co. It also organized the Pensacola Warehousing Co. with a capital stock of $200,000 to operate the storage and warehouse department. The factorage end of the business was operated by the West Florida Naval Stores Co.

*804 In financing producers the West Florida Naval Stores Co. secured in each case at the time the contract was signed notes covering the total amount of capital to be furnished by it to the producer to enable him to carry on the production of naval stores during the season. In a majority of cases the notes were secured by mortgages on the producer's property. On debit*2517 balances the West Florida Naval Stores Co. charged interest at the rate of 8 per cent per annum and on credit balances it paid interest at the same rate. The company borrowed money from banks by depositing these notes and warehouse receipts for rosin and turpentine as collateral and by securing from its stockholders personal guaranty of the loans. The usual ratio of collateral deposited to money borrowed was 3 to 2. During the years 1918 and 1919 the monthly borrowings averaged $212,134.26 and $180,615.15, respectively. In addition to such monthly borrowings the company borrowed from its stockholders in 1918 and 1919, $37,933.42 and $91,053.01, respectively. The amounts borrowed from stockholders were set up in its books as accounts payable.

Consolidated balance sheets as of December 31, 1917, December 31, 1918, and December 31, 1919, appear as follows:

*2518 *806 The business conducted by the Jacksonville Naval Stores Co. is substantially the same as that conducted by the petitioners, being dealers in the same commodities, in the same form of organization, and in the same State. The percentages of income and profits tax paid by it to its net income for the years 1918 and 1919 were 11.8 per cent and 9.81 per cent, respectively, whereas that determined to be payable by the petitioners is 25.6 per cent and 28 per cent, respectively.

OPINION.

SMITH: In determining a deficiency for the year 1918 the respondent denied the claim of the petitioners for assessment under the provisions of section 328 of the Revenue Act of 1918. He appears to have considered the petitioners' claim for relief under section 328 for the calendar year 1919 but in his deficiency letter stated:

After careful consideration and review your application under the provisions of section 327 for assessment of your profits tax as prescribed by section 328 of the Revenue Act of 1918 has been denied inasmuch as the audit disclosed no exceptional hardship evidenced by gross disproportion between the tax computed without benefit of the above section and the tax*2519 computed by reference to the representative corporations specified in section 328.

Counsel for the petitioners contends that their inability to reflect in invested capital the value of good will and contracts acquired by them at or about the time they were organized, coupled with the amount of borrowed capital employed in their business, created abnormalities affecting invested capital.

The only information which we have with regard to any value of the good will of the Pensacola Grocery Co. is the earnings of that company for the years 1906 to 1910, inclusive, upon the capital and surplus of the company. Although such good will may have had a value, we are of the opinion that the earnings alone do not prove such value. Apparently the good will did not attach to the name of Pensacola Grocery Co. for the name was abandoned upon the organization of the West Florida Naval Stores Co. There appears to be no basis for the contentions of petitioners that the Pensacola Grocery Co. had good will of the value of $125,000, which was paid into the West Florida Naval Stores Co. at the date of its organization. We have no means of knowing the value, if any, which the contracts made by certain*2520 stockholders with certain producers of naval stores in 1911, and which were paid in to the West Florida Naval Stores Co. upon its organization had at the date of assignment to the new corporation. The evidence indicates that the most successful companies dealing in naval stores had arrangements with producers of naval stores such as the West Florida Naval Stores Co. had. We are not apprised of the value of such contracts. *807 We can not determine whether this fact was of such importance as to produce an abnormality of invested capital.

We are furthermore of the opinion that the borrowings made by the petitioners were not of such moment as to produce an abnormality in invested capital. The petitioners paid a good rate of interest upon such borrowings and the interest paid was deductible from gross income in income-tax returns.

In proof of the petitioners' contention that the income and profits tax determined to be payable by them would, without relief under section 328, work upon petitioners an exceptional hardship evidenced by gross disproportion between the tax computed without the benefit of the section and the tax computed by reference to representative corporations, *2521 it instances the tax paid by the Jacksonville Naval Stores Co. The only evidence which we have with respect to the tax paid by that company is that it was 11.8 per cent of its net income for 1918, and 9.85 per cent of its net income for 1919. We can not determine from these facts alone that the Jacksonville Naval Stores Co. is similarly circumstanced with respect to gross income, net profits per unit of business transacted, and capital employed, and therefore a proper comparative to be used in determining tax liability under section 328.

For lack of evidence as to such abnormalities affecting invested capital as would warrant the determination of tax liability under section 328 and of evidence as to what tax proper comparatives paid, the denial of relief under section 328 made by the Commissioner is sustained.

Judgment will be entered for the respondent.

Considered by TRUSSELL, LOVE, and LITTLETON.