American Radio Tel. Co. v. Commissioner

American Radio Telephone Company, a Corporation in Process of Dissolution by Cassius E. Gates, Liquidating Trustee Thereof, Petitioner, v. Commissioner of Internal Revenue, Respondent American Radio Tel. Co. v. Commissioner Docket No. 14308 United States Tax Court 12 T.C. 140; 1949 U.S. Tax Ct. LEXIS 284; February 3, 1949, Promulgated *284 Decision will be entered for the respondent. Petitioner was organized as a corporation in 1924. Certain property was transferred to petitioner by two individuals who owned the property in consideration of petitioner issuing to them all of of its shares of stock, which had a par value of $ 100,000. The property transferred did not have an adjusted cost basis to the transferors in excess of $ 15,000. Held, that in determining petitioner's equity invested capital for excess profits tax purposes under section 718 (a) (2), I. R. C., petitioner's cost basis of such property is not in excess of $ 15,000. Hence, the Commissioner did not err in refusing to grant petitioner an excess profits credit based on equity invested capital which would have been greater than a credit based on earnings. Harry Henke, Jr., Esq., and Frank L. Mechem, Esq., for the petitioner. Douglas L. Barnes, Esq., for the respondent. Black, Judge. BLACK *140 The Commissioner has determined a deficiency against petitioner in income tax for the year 1945 of $ 53.12 and deficiencies in excess profits tax as follows: 1943, $ 10,001.14; 1944, $ 12,672.72; and 1945. *141 $ 406.50. In *285 regard to his determination of the deficiencies the Commissioner stated in his deficiency notice as follows: Excess profits credits based on income has been allowed in the amount of $ 3,011.54 computed in accordance with section 713 (f). Since you have failed to establish the basis of property paid in for stock there is no basis for the allowance of excess profits credit based on invested capital. It is held that no unused excess profits credit adjustment is allowable for the taxable years 1943 and 1944, since the unused excess profits credit for 1941 is absorbed by the adjusted excess profits net income for 1942 computed without deduction of specific exemption and unused excess profits credit carry-over. Petitioner does not assign any error as to the Commissioner's determination of the income tax deficiency for the year 1945. Petitioner does assign error as to respondent's determination of the excess profits deficiencies for each of the taxable years. The substance of petitioner's assignments of error is that the Commissioner erred in each of the taxable years in not allowing petitioner an excess profits credit based on invested capital instead of a credit based on earnings. Petitioner*286 alleges that upon its organization in 1924 property was paid in for its stock having a value of $ 100,000 and that petitioner's invested capital should be allowed on that basis in determining its excess profits credit for each of the taxable years. FINDINGS OF FACT. The American Radio Telephone Co. was organized as a corporation under the laws of the State of Washington on November 8, 1924, and has been engaged in the operation of a radio broadcasting station at Seattle, Washington, now known as KXA. In the years 1924 and 1925 it also used the call letters KFQX or KTCL for identification. The corporation's tax returns for the years 1943, 1944, and 1945 were filed with the collector of Internal Revenue at Tacoma, Washington. In its excess profits tax returns for the years ended December 31, 1943 and 1944, petitioner computed its excess profits credit under the provisions of section 714 of the Internal Revenue Code and included as part of the equity invested capital the amount of $ 100,000 representing the entire face amount of petitioner's stock which was issued at the time of incorporation. In this connection petitioner stated in its excess profits tax returns for 1943 and 1944*287 as follows: "Cash property and franchise paid in for stock $ 100,000." Petitioner's excess profits return for 1945 stated that $ 30,000 had been paid in property exclusive of franchise and its excess profits credit was figured accordingly. Petitioner accompanied this return with a statement reading as follows: *142 This return has been prepared in accordance with the findings of an Internal Revenue Agent in an audit of prior years returns. The Agent has disallowed as Invested Capital the amount shown as Franchise, namely $ 70,000. The Agents findings are being protested and are not agreed to. In filing this return in accordance with the findings of the Agent we hereby do so without prejudice and pay the tax under protest reserving all rights and claims to refunds in the event our protests and the invested capital, as filed in prior years, are found to be correct. The property paid in for the stock of petitioner corporation on November 8, 1924, consisted entirely of radio broadcasting equipment, which was referred to in a letter of that date and recorded in the corporate minutes as follows: Seattle, Washington, November 8, 1924. American Radio Telephone Company, Seattle, *288 Washington. Gentlemen: We hereby offer to sell, assign and transfer to you that certain set of apparatus and instruments suitable and used for radio communication now located and used at house No. 3757 Ridgeway Place, Seattle, Washington, together with all accessories and advantages pertaining thereto, the same being more particularly described in the Bill of Sale tendered herewith and which we propose to execute and deliver to you, in return for the entire capital stock of your company, to-wit, 1000 shares, to be issued 500 shares to Roy Olmstead and 500 shares to Alfred M. Hubbard. Yours very truly, Roy Olmstead Alfred M. Hubbard. The offer to the corporation was accepted on November 8, 1924. Roy Olmstead was then issued 500 shares of stock and 500 shares were issued to Alfred M. Hubbard (par value $ 100,000). This was in accordance with the terms of the offer. The radio broadcasting equipment was acquired by Olmstead and Hubbard some time during the spring or summer of 1924. Roy Olmstead was engaged in other business activities and had no technical knowledge of radio, while Alfred Hubbard had some familiarity with the subject. All of the money furnished in the purchase or *289 construction of the broadcasting equipment was advanced by Olmstead, but it was spent primarily by Hubbard. The money was spent without keeping any record of the amount or type of expenditures and all of the transactions were handled in cash. Olmstead supplied not less than $ 10,000 and not in excess of $ 15,000 to Hubbard for the purpose of constructing and operating the radio station in the year 1924. *143 The radio broadcasting equipment was installed in the home of Olmstead, located at 3757 Ridgeway Place, Seattle, Washington. The transmitter consisted of a wooden frame in an upstairs bedroom to which were attached the various tubes, condensers and coils necessary for the operation of the station. A motor generator for the power supply was in an adjacent clothes closet or in the basement. The antenna consisted of two wooden poles similar to flagpoles, which were outside the residence, one being attached to the house itself. The equipment was known as a "composite" transmitter and was described as a "Westinghouse type." It was largely homemade and was not built or tested as a unit by any professional radio manufacturer. The General Appraisal Co. is an appraising company*290 which since 1902 has made appraisals of industrial and residential property, usually for finance or fire insurance purposes. A detailed appraisal of all the contents of the Roy Olmstead residence at 3757 Ridgeway Place, Seattle, Washington, was made by the General Appraisal Co. on or about October 30, 1924, for fire insurance purposes. Included in this detailed appraisal of the contents of the Olmstead residence were the following items located in the radio room of that residence and appraised at the figures noted: 1 De Forest Radio phone, type O, Series 172, 60 cycles, alternating current supply, manufactured by the Forest Radio Telephone and Telegraph Company, New York City $ 475.00 1 From 1,000 to 1,500 watt radio telephone and telegraph transmitter, Westinghouse type, with Westinghouse generator set battery circuit, etc., complete in every detail, manufactured by the Radium X-ray Company, Seattle, Washington, installed 75,000.00 All of the foregoing equipment could have been duplicated in the year 1924 for approximately $ 10,000. Certainly it would not have cost more than $ 15,000 to duplicate the equipment. A license from the Department of Commerce permitting petitioner*291 to operate the radio station cost the petitioner nothing. The equipment transferred by Olmstead and Hubbard to the petitioner corporation in 1924 did not have a cost or value equal to par of the $ 100,000 stock issued. The broadcasting equipment transferred to the American Radio Telephone Co. on November 8, 1924, in exchange for the stock of that corporation did not cost Alfred Hubbard and Roy Olmstead in excess of $ 15,000. For the purpose of computing petitioner's equity invested capital, the amount of property paid in for stock in the year 1924 was not in excess of $ 15,000. *144 OPINION. Petitioner, in the computation of its excess profits tax, is entitled to an excess profits credit based on invested capital or based on earnings, whichever is greater. See sec. 712, I. R. C. In its excess profits tax returns for 1943 and 1944 petitioner claimed excess profits credit based on an initial capital investment of $ 100,000 and computed its excess profits credit under section 714 of the Internal Revenue Code. In its 1945 return it based its credit, under protest, on an initial investment of $ 30,000. In its brief petitioner, after referring to the appraisal made in 1924 by*292 the General Appraisal Co. referred to in our findings of fact, says of that appraisal: That appraisal included the following items, together with their current cost at that time: 1 De Forest radio telephone, type O, Series 172, 60 cycles, alternating current supply, manufactured by the Forest Radio Telephone and Telegraph Company, New York City $ 475.00 1 from 1000 to 1500 watt radio telephone and telegraph transmitter, Westinghouse type, with Westinghouse generator set, battery circuit, etc., complete in every detail, manufactured by the Radium X-Ray Company, Seattle, Washington, installed, 75,000.00 The total of those items of radio equipment is $ 75,475.00. This sum, we submit, is the basis of that property and petitioner is, in consequence, entitled to avail itself of that sum in computing its invested capital for excess profits tax purposes. As disclosed by our findings of fact, Olmstead and Hubbard were the original owners of this radio equipment and they paid it in to the corporation (petitioner) in consideration of the issuance to them of petitioner's stock of 1,000 shares (par value of $ 100 per share). Petitioner concedes that its basis of cost for the property *293 paid in is the basis of cost to the transferors. Petitioner does not claim that it has any books or records to prove what this radio equipment cost Olmstead and Hubbard. It relies largely for its proof of cost on the appraisal made in 1924 for Olmstead by the General Appraisal Co. for fire insurance purposes on property situated in his private residence. The Commissioner, in his determination of the excess profits tax deficiencies, has determined that petitioner has failed to establish the basis of property paid in for stock and that hence there is no basis for the allowance of excess profits credit based on invested capital. In his determination of the deficiencies respondent has allowed petitioner an excess profits credit of $ 3,011.54 based on income computed in accordance with section 713 (f) of the code. Petitioner does not contest the correctness of respondent's computation *145 of the excess profits credit if the income method is to be used. Petitioner does insist, however, that it has made sufficient proof of its original invested capital to justify the use of that method in determining its excess profits credit. The applicable section of the code is printed in the*294 margin. 1 Inasmuch as it was Olmstead and Hubbard who transferred the property in question to petitioner and received its shares of stock in equal proportion, it was their cost basis which would determine petitioner's cost basis and, hence, the amount of equity invested capital it would be entitled to use. See Ralphs-Pugh Co., 7 T. C. 325. In that case, among other things, we said: * * * If the contracts had no "cost," or basis, to the partnership, there is nothing to be included in petitioner's equity invested capital. Petitioner contends that the contracts in question had substantial value. It may be that they did have substantial value. But petitioner's equity invested capital is not based on the value of the contracts transferred to it, but only on the cost basis of the contracts to the partnership, and, under the limited evidence before us, we are unable to find that the contracts cost the partnership any definite amount. We thereupon held against the taxpayer in that case because of failure of proof. *295 Unlike the Ralphs-Pugh Co. case, supra, where we were not able to make any finding that the property paid in by the incorporators cost them anything, in the instant case we are able to make a finding that the property which Olmstead and Hubbard paid in to petitioner for its 1,000 shares of stock had a cost basis to them of not less than $ 10,000 and not more than $ 15,000. This finding, however, does not help petitioner, because we would have to find that the property in question had a cost basis to Olmstead and Hubbard of something around $ 40,000 before it would do petitioner any good. Such a finding we are unable to make from the record which we have before us. As we have already stated, petitioner concedes that it has no books or records which show the cost of this property to Olmstead and Hubbard. It relies largely on an appraisal made in 1924 by the General Appraisal Co. of Seattle for fire insurance purposes. Petitioner's argument in substance is that, because this appraisal was based on *146 replacement costs at the time it was made, it should be accepted by us as satisfactory evidence of what the property cost Olmstead and Hubbard near the time when the *296 appraisal was made. If this appraisal were all the evidence that we have, we would have to decide whether it was sufficient to overcome the presumptive correctness of respondent's determination. But it is by no means all the evidence that we have. Respondent has offered affirmative evidence that the property could not possibly have cost Olmstead and Hubbard anything like the figures which the appraisal names. Roy Olmstead was called as a witness by respondent. The substance of his testimony was that he was one of the original incorporators of petitioner and was associated with Alfred Hubbard in its incorporation. Hubbard did the purchasing of the radio equipment and Olmstead supplied the money. He stated that it would be difficult for him to say how much money he furnished Hubbard with which to purchase and install the radio equipment, but he would say the aggregate amount would be between $ 10,000 and maybe as high as $ 15,000. The testimony of other witnesses called by respondent was to the effect that the property which Olmstead and Hubbard transferred to petitioner in consideration of the issuance to them of its capital stock could not have cost them in excess of $ 15,000. *297 Some of these witnesses impressed us as being well qualified to testify as to the cost of radio equipment. We are, therefore, unable to accept the appraisal which petitioner has introduced in evidence as proof of the fact that the property transferred by Olmstead and Hubbard to petitioner had a cost basis to them of $ 75,475, as petitioner claims. Not only has petitioner failed to overcome the presumptive correctness of respondent's determination, but respondent has offered evidence which convinces us that the cost basis of the property in question to Olmstead and Hubbard, and hence to petitioner, was not in excess of $ 15,000. Petitioner is, therefore, not entitled in the taxable years to an excess profits credit based on invested capital which exceeds the credit allowed by respondent based on earnings. Decision will be entered for the respondent. Footnotes 1. SEC. 718. EQUITY INVESTED CAPITAL. (a) Definition. -- The equity invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following amounts reduced as provided in subsection (b) -- (1) Money paid in. -- Money previously paid in for stock, or as paid-in surplus, or as a contribution to capital; (2) Property paid in. -- Property (other than money) previously paid in (regardless of the time paid in) for stock, or as paid-in surplus, or as a contribution to capital. Such property shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange. If the property was disposed of before such taxable year, such basis shall be determined under the law applicable to the year of disposition, but without regard to the value of the property as of March 1, 1913. * * *↩