Camden Woolen Co. v. Commissioner

*1277 This proceeding results from the determination of a deficiency in income and profits taxes for the year 1921 amounting to $6,656.59.

Petitioner alleges error with reference to the following issues: (1) An increase in net income, in the amount of $660.70, attributable to the income tax for 1920, which respondent considered to have been deducted from income in the return; (2) a reduction in the amount of $2,394.31 of the allowance claimed by petitioner for exhaustion, wear and tear; (3) failure to compute the profits tax under the provisions of sections 327 and 328 of the Revenue Act of 1921.

At the hearing respondent conceded that net income is overstated in the amount of $660.70, thus disposing of the first issue.

FINDINGS OF FACT.

Petitioner is a Maine*3372 corporation with its principal office at Camden, Me., and is engaged in the manufacture of woolen cloth.

Prior to 1920, petitioner had operated unprofitably for a number of years. At the beginning of the taxable year the mill buildings, machinery, and equipment were in a run-down dilapidated condition and petitioner was in a very poor financial condition. Power was derived from a water wheel which developed 60 horsepower instead of its original rating of about 150 horsepower, and which required frequent repairs. Auxiliary power which has not *1278 been used since 1921 was furnished by a steam engine of obsolete type, and 2 old boilers in bad condition. Both boilers were condemned in 1922 due to their thin outer shells. In the dye house were 4 vats with leaky steel bottoms and a wool dryer; the dryer had been in use about 3 years and was in good condition. Ordinarily the useful lives of the vats averaged from 5 to 10 years, and of the wool dryer about 10 years. In another location were located a bur picker, bought in 1920, having a useful life of 5 to 7 years, and a rag picker which was very old and practically worn out. There was a mixing picker bought in 1917 and*3373 discarded in 1923, being replaced by a new one. In the card room were 8 sets of cards running off level and with worn journals. Ordinarily these machines have a useful life of 20 years. In the spinning room were 9 mules ordinarily of useful lives of 10 to 15 years. Three were scrapped within 2 years and 2 more within 3 years. Two of the mules were purchased during the World War. There were 3 dresser frames, of useful lives of 10 years. They were not in good condition. One was discarded within a year or two. There were also some spoolers which were in fair condition and they would probably last 15 years. The weaving department consisted of 40 looms with average useful lives of 20 years when operated normally. They were old machines which were run hard in the taxable year and they gave constant trouble. They were power looms with the shuttles and the boxes on the side in bad shape. In the wet-finishing department were fulling machines and 3 washers with average useful lives of 5 to 7 years. They were in very bad condition. Upstairs in this department was the dry-finishing machinery, including a new shears, all in good condition. The shears would last 15 to 20 years. There*3374 was a napper lasting 10 to 15 years, and a dryer lasting about 15 years.

The production of petitioner amounted as follows: For 1920, 240,000 yards; for 1921, 430,000 yards. The years 1917, 1918, and 1919 were about equal to 1921. During 1921 for about 50 per cent of the time the mill was run double time, employing a day shift of 9 hours, 36 minutes, and a night shift of 12 hours.

In 1921 the buildings were entirely of frame construction. The main building was about 155 feet long, 80 feet wide and 3 stories high. There was no cellar. The sills and uprights had suffered from dry rot, causing the uprights to sag. The roof leaked. A front tower was anchored to the mill building to prevent its falling. The boiler house was open on one side. A boarding house across the street had not been occupied for 6 or 7 years, all of its window glass was out and the plastered ceilings down.

The records of petitioner for prior years are in bad condition, and for much of the plant and equipment the date of acquisition and cost are not disclosed.

*1279 In the taxable year the amount of $1,198.16 salaries to officers was paid to the president-treasurer. The managing director*3375 served full time during 3 months and a few weeks during 9 months, all without compensation, due to the financial condition of petitioner. A deduction was claimed on the return for office and administration salaries amounting to $12,465.16. This included the salaries of a superintendent and assistant superintendent.

Sales were handled on a commission basis by a firm of factors, the owner of the capital stock of petitioner.

The capital stock of petitioner was acquired in 1920 by a firm of factors located in New york. The indebtedness of petitioner to this firm at the beginning of the taxable year amounted to $72,062.67, and at the end of the year, $6,803.23. In addition, money borrowed from banks amounted at the beginning of the year to $21,500, and at the end of the year to $15,000. According to the general ledger the average monthly balances due these creditors exceeded in the aggregate $60,000 for the taxable year. The bank loans were secured through the personal indorsement of the managing director.

The average invested capital allowed by respondent for the taxable year was as follows:

*3376 The net income and profit tax computed by respondent amounted as follows: net income, $47,466.26; profits tax, $12,711.93.

OPINION.

LOVE: The first issue was disposed of at the hearing by the admission of respondent that the net income was overstated as claimed by petitioner.

The second issue relates to the rates of allowance for exhaustion, wear and tear of the buildings, machinery and equipment of petitioner. In the return petitioner computed allowances at rates of 3 per cent on the buildings and 7 1/2 per cent on the machinery and equipment. Respondent has reduced these rates to 2 1/2 and 5 per cent, applied to the same bases used by petitioner. We are satisfied from the testimony of the witnesses for petitioner that the assets were in rather a deplorable condition in the taxable year, yet the plant *1280 was operated on an overtime basis and production at least equaled if it did not exceed prior-year averages, so that it is probable that the operations took a toll of wear and tear in excess of average rates applicable to normal conditions. In our view the conditions were far from normal and this question of depreciation is peculiarly one of fact. Under the*3377 circumstances recourse should be had to an intimate knowledge of the actual conditions which prevailed. This is supplied by the president, formerly the managing director, and the general superintendent, both men of experience, who determined the allowances claimed from their experience and upon careful consideration of conditions and of the year's operations. They have described in detail the condition of the principal assets, and the operating factors. We see no reason for a disallowance of the deduction claimed in the return by petitioner, and conclude that it should be allowed.

In the remaining issue petitioner makes application for a comparison with representative corporations, with relation to its excess-profits tax, as provided in sections 327 and 328 of the Revenue Act of 1921. Section 327 provides in part as follows:

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 if determined without benefit of this section would, owing to abnormal conditions affecting the capital or income of the corporation, work upon the corporation*3378 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. * * *

The application is based upon two grounds (1) an abnormality of income due to a failure to pay usual officers' salaries, and (2) an abnormality of capital through operation with borrowed capital which is not allowable in statutory invested capital.

(1) The operations of petitioner were conducted under the care of a superintendent and an assistant superintendent, both resident, who were paid salaries which were deducted from income on the return. In addition, the managing director, serving without salary in the taxable year, gave his full time to petitioner during three months and a small part of his time for the remaining nine months when he was occupied elsewhere in connection with other interests. The selling end was handled on a commission*3379 basis by the firm of factors which owned the capital stock of petitioner during the taxable year. The managing director testified to the amounts of salaries *1281 paid to their officers by other concerns within his knowledge but it does not appear whether these salaries were for full or for part time. Apparently the managing director was a man of experience and ability, but even so a reasonable salary allowance for his part-time services would amount to but a few thousand dollars, certainly not enough in our opinion to constitute an abnormality which would result in "exceptional hardship." Cf. .

(2) Relative to the "borrowed money" the record shows that petitioner was in a financial condition described as "very poor" and it was necessary to borrow money from the bank. In addition the firm of factors, the stockholders of petitioner, granted credit during the year. The average of the aggregate of these liabilities amounted to less than 40 per cent of the total economic capital claimed. We do not know whether under normal conditions it was customary for the factors to require immediate payment. Except for*3380 the discussion of the plant relative to depreciation we are left to conjecture what were the assets of petitioner. Obviously more is required than is afforded by the record to enable a conclusion that the conditions were abnormal. Respondent is sustained. Cf. ; .

Judgment will be entered under Rule 50.