Laurens Cotton Mills v. Commissioner

*443 The respondent determined a deficiency in unjust enrichment taxes for the fiscal year ended September 30, 1936, in the amount of $1,846.30. The sole question raised by the pleadings on which proof was submitted at the hearing was whether respondent erred in including the net profit derived from a grocery store as net income derived from the sale of articles with respect to which the processing tax was imposed.

FINDING OF FACT.

The petitioner is a corporation with principal office at Laurens, South Carolina. The return for the period here involved was filed with the collector of internal revenue at Columbia, South Carolina.

During the years here involved petitioner manufactured cotton cloth, and accordingly was subject to the provisions of the Agricultural*869 Adjustment Act, which became effective with respect to cotton on August 1, 1933, and imposed a tax upon petitioner in the amount of 4.2 cents for each lint pound of cotton processed by petitioner.

The Agricultural Adjustment Act was declared unconstitutional by the United States Supreme Court on January 6, 1936.

During the taxable year ended September 30, 1936, petitioner paid no processing taxes to the collector, but enjoined the collection of such taxes.

After the passage of Title III of the Revenue Act of 1936, petitioner filed a timely unjust enrichment tax return. In this return petitioner set out the required information with respect to its mill margins during the taxable year and during the six-year comparative period prescribed by section 501(f) of the Revenue Act of 1936.

For income tax purposes petitioner's net income for the year ended September 30, 1936, was $17,460.40. Of this net income of $17,460.40, the amount of $3,123.59 was income derived from a farm and $21,253.82 was income from a store, both operated by petitioner. In the return these items were segregated and shown as "Other Income." In his notice of deficiency respondent excluded this farm income*870 from petitioner's total net income, and determined that petitioner's net income for the year from the sale of articles with respect to which the processing tax was imposed was $14,347.01.

During the taxable year (and for many years prior to and since that time) petitioner operated a retail store. About half the merchandise sold in the store consisted of groceries, and related items *444 such as fresh meats, fruits, and vegetables. The store also sold shoes, dry goods, hardware, toys, bicycles, and other general merchandise.

None of the cotton cloth manufactured in the mill, with respect to which the processing tax was imposed, was sold in the store.

Petitioner operated the store as an independent enterprise carried on solely for the profits to be derived from its operation. Over the period of its operation the store has been a profitable investment for petitioner. The store was in active competition with other stores which were independently owned, and the prices charged in petitioner's store were comparable to the prices charged at competing stores.

The store and the mill village, where most of petitioner's employees live, were located within the city limits*871 of Laurens, South Carolina, a town of about 7,000 population with a shopping district from which the merchants made deliveries to the mill district. In addition to the stores in the central shopping district of Laurens, South Carolina, there were a number of independently owned stores, competing with petitioner's store, immediately adjacent to petitioner's mill village. Several of these stores were closer than petitioner's store to sections of the mill village. A great many of the competitors of petitioner's store sold on credit.

The employees of petitioner's cotton mill were under no compulsion to buy at petitioner's store. About half of their purchases were made at competing stores.

Although 90 percent of the customers of petitioner's store were employees of petitioner's mill, the store sold to and solicited business of people who were not employees of the mill. The store was operated by a store manager and six or eight clerks, all of whom devoted their full time to the operation of the business.

The net income from the store for the taxable year ended September 30, 1936, was shown on petitioner's books to be $21,253.82. This amount was regarded by petitioner for all*872 business purposes as the net income for the year from store operations and the figure was entered in petitioner's ledger in the regular course of business.

In determining that its store net income for the taxable year was $21,253.82, petitioner first computed store gross income by deducting cost of goods sold from sales. From gross income there were deducted the salaries of all store employees, interest at 6 percent per annum on the average monthly debit balance of the store account in petitioner's books, and a flat charge of $1,000 a year to cover overhead items such as depreciation, heat, light, and water incurred by petitioner on behalf of the store but not allocated directly to the store on petitioner's books.

The charge of $1,000 a year in lieu of a charge for specific overhead items was considered by petitioner's officials to be adequate to *445 cover such items. A proper charge for overhead is $3,500. With the overhead increased as indicated, the net income of the store for the taxable year amounted to $18,753.82.

OPINION.

VAN FOSSAN: Section 501(a)(1) of the Revenue Act of 1936 ¹ limits the unjust enrichment tax to 30 percent of the taxpayer's net income*873 for the entire taxable year from the sale of articles with respect to which the excise tax was imposed. Petitioner's entire net income for the taxable year was $17,460.40, from which respondent deducted $3,123.59, the same being income from a farm and having no relation to net income from the sale of articles with respect to which the processing tax was imposed. Petitioner contends that the resultant sum of $17,347.01 should be further reduced by deducting, as an unrelated activity, the sum of $21,253.82, the net profits from the operation 0f the store. If petitioner be sustained in this there will be no unjust enrichment tax due, because petitioner derived no net income from the sale of articles with respect to which the processing tax was imposed.

*874 The facts dictate that petitioner's contention should be sustained. The store is operated not as a unit of the mill, but as an independent business. It faced keen competition in merchandise, prices, and service from several competitors. The fact that most of its patrons were mill employees does not indicate that the store was an integrated part of the mill operation. It sold for cash or credit to patrons outside the mill rolls. The mill employees were under no compulsion to buy at the company store. It survived and prospered only by successfully competing with other stores.

Respondent's principal argument respecting this phase of the case is that certain items of overhead were not accurately and separately kept, a flat charge of $1,000 per year being made to cover depreciation, light, fuel, water, etc. On the record we are convinced that $1,000 is an inadequate sum and we have accordingly fixed the sum of $3,500 as a proper charge for overhead. The fact that we have increased the amount chargeable to overhead does not require a conclusion different from that above indicated, i.e., that the operation of the store was an independent business enterprise carried on for profit, *875 only incidentally related to the mill operation. Respondent excluded the income *446 from the farm in making his computations. In our opinion he should also have excluded the net income from the store.

We have found that the net income of the store amounted to $18,753.82. If this be deducted from petitioner's net income for the taxable year, it is obvious that petitioner derived no net income from the sale of articles with respect of which the processing tax was imposed and no tax is due.

Decision will be entered for the petitioner.