Block One Thirty-Nine, Inc. v. Commissioner

Block One Thirty-Nine, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Block One Thirty-Nine, Inc. v. Commissioner Docket Nos. 10925, 26636, 26637 United States Tax Court 17 T.C. 1364; 1952 U.S. Tax Ct. LEXIS 269; February 21, 1952, Promulgated *269 Decisions will be entered under Rule 50. Petitioner claimed relief for excess profits taxes under section 722 (c) (3) because its invested capital was abnormally low for each of the taxable years. Held, that where its proposed credit under the income method is smaller than the credits actually allowed under the invested capital method, it is not entitled to relief. Charles H. Draper, Esq., and Marshall McDonald, *270 Esq., for the petitioner. Irene F. Scott, Esq., for the respondent. Black, Judge. BLACK *1364 These proceedings have been consolidated. In Docket No. 10925, for the fiscal year ending February 28, 1943, the deficiency notice discloses that the Commissioner has determined an overassessment in petitioner's income tax of $ 1,933.46 and a deficiency in petitioner's excess profits tax of $ 5,903.37. The deficiency notice further states: It is held that you have not established that the tax computed under subchapter E of chapter 2 of the Internal Revenue Code, results in an excessive and discriminatory tax within the provisions of section 722 (a) and (c) of the Code. It is further held that your excess profits credit based on invested capital of $ 2,118,911 for the fiscal year ended February 28, 1943, is an adequate standard for determining excess profits tax and that you have not established any amount differing therefrom to be used as a constructive average base period net income for such purpose. Accordingly, the claim for refund contained in Form 991, Application for Relief under section 722 of the Internal Revenue Code is disallowed. To the foregoing determination of*271 the Commissioner, petitioner does not assign error as to the deficiency which respondent has determined in petitioner's excess profits tax, but petitioner does assign error as to the action taken by the Commissioner in denying petitioner's *1365 claim for relief under section 722 of the Code. These errors assigned by petitioner are as follows: (a) With respect to the fiscal year ended February 28, 1943, the Commissioner erred in disallowing in full Petitioner's claim for refund * * * relating to the application of Section 722 of the Internal Revenue Code, filed November 15, 1943, which said claim was amended by amended claim on Form 991 calling for a refund of $ 71,352.42, and filed on May 11, 1946, * * * and by claim on Form 843 filed on May 11, 1946, * * * calling for an additional $ 44,894.05 in addition to the $ 26,458.36 claimed on the said original claim filed November 15, 1943. (b) With respect to the fiscal year ended February 28, 1943, the Commissioner erred in failing to find that the Excess Profits Tax involved, as computed without the benefit of Section 722 (c) (3) results in an excessive and discriminatory tax, and that the amounts claimed as normal earnings in *272 Petitioner's application for relief under Section 722 (c) (3) are fair and just. (c) With respect to the fiscal year ended February 28, 1943, the Commissioner erred in failing to determine that the Petitioner is entitled to a Constructive Average Base Period Net Income of One Hundred Seventy-six Thousand, Five Hundred Fifty-five Dollars, Eighty-nine Cents ($ 176,555.89), or an Excess Profits Credit under the Income Method of 95% of $ 176,555.89, or One Hundred Sixty-seven Thousand, Seven Hundred Twenty-eight Dollars, Ten Cents ($ 167,728.10), as claimed in its application for relief. In an amendment to the petition filed at the hearing the above paragraph was changed to read as follows: (c) With respect to the fiscal year ended February 28, 1943, the Commissioner erred in failing to determine that the Petitioner is entitled to a Constructive Average Base Period Net Income of Four Hundred Eighty-two Thousand, Six Hundred Seventy-two Dollars, Fifty Cents ($ 482,672.50), or an Excess Profits Credit under the Income Method of 95% of $ 482,672.50, or Four Hundred Fifty-eight Thousand, Five Hundred Thirty-eight Dollars, Eighty-eight Cents ($ 458,538.88), as claimed in its application for*273 relief, as amended. In Docket No. 26636, in the deficiency notice attached to the petition, the Commissioner states as follows: You are advised that the determination of your income tax liability for the taxable years ended February 28, 1944 and 1945, discloses overassessments of $ 2,480.57 and $ 2,407.40, respectively; that the determination of your declared value excess profits tax liability for the taxable year ended February 28, 1945, discloses a deficiency of $ 1,628.90; and that the determination of your excess profits tax liability for the taxable years ended February 28, 1944 and 1945, discloses deficiencies of $ 19,255.35 and $ 18,763.65, respectively, to all of which you have agreed. After careful consideration of your applications for relief under section 722 of the Internal Revenue Code, filed June 23, 1947, it has been determined that you have not established your right to the relief requested in your applications. In accordance with the provisions of sections 272 and 732 of the Internal Revenue Code, notice is hereby given of the deficiencies mentioned, and of the disallowance of the claims for refund asserted in your applications for relief (Forms 991). *1366 To*274 the foregoing determinations made by the Commissioner the petitioner assigns three errors which are identical in form and substance (except as to taxable years and amounts) as the errors assigned in Docket No. 10925. In Docket No. 26637, in the deficiency notice attached to the petition, the Commissioner states as follows: You are advised that the determination of your income tax liability for the taxable period March 1 to December 31, 1945, discloses a deficiency of $ 2,785.98, and that the determination of your excess profits tax liability for the taxable period March 1 to December 31, 1945, discloses an overassessment of $ 36,238.44, to which you have agreed. After careful consideration of your application for relief filed June 23, 1947, it has been determined that you have not established your right to relief requested in your application. In accordance with the provisions of sections 272 and 732 of the Internal Revenue Code notice is hereby given of the deficiency mentioned and of the disallowance of the claim for refund in your application for relief (Form 991). To the foregoing determinations made by the Commissioner the petitioner assigns three errors which are identical in*275 form and substance (except as to taxable years and amounts) as the errors assigned in Docket No. 10925. Thus it results that we have no issues as to the deficiencies determined by respondent. The issues raised by petitioner's assignments of error relate only to the Commissioner's denial of relief to petitioner under section 722 of the Internal Revenue Code. Initially in its applications for relief petitioner claimed the following refunds: Docket No. Year ended Refund claims 10925 February 28, 1943 $ 26,458.36 26636 February 29, 1944 60,575.76 26636 February 28, 1945 47,379.34 26637 March 1 to December 31, 1945 27,495.04 Petitioner claimed much larger amounts of refunds in its amended petitions. These claims aggregated slightly less than one million dollars and, if allowed, would mean a refund of most of the excess profits taxes which petitioner has paid in the taxable years. In its supplemental brief and in its reply brief petitioner now claims that it is entitled to refunds of much smaller amounts as follows: Docket No. Year ended Refund claims 10925 February 28, 1943 $ 73,352.41 26636 February 29, 1944 60,575.76 26636 February 28, 1945 44,379.34 26637 March 1 to December 31, 1945 27,495.04 *276 *1367 FINDINGS OF FACT. Some of the facts have been stipulated and as stipulated are adopted as part of our Findings of Fact. Block One Thirty-Nine, Inc., hereinafter called the petitioner, is a corporation incorporated under the laws of the State of Texas in 1941. The tax returns for the years in question were all filed with the collector of internal revenue for the first district of Texas. From March 7, 1941, until May 8, 1944, petitioner was a wholly owned subsidiary of Realty Management Company, a corporation incorporated under the laws of the State of Texas in December 1934. From May 8, 1944, until December 24, 1945, petitioner was a wholly owned subsidiary of Bankers Mortgage Company, a corporation incorporated under the laws of the State of Texas prior to 1936. On December 24, 1945, the petitioner became a wholly owned subsidiary of Commerce Company. Petitioner was organized to acquire contiguous and neighboring downtown properties in Houston, Texas. 1 The properties were purchased for the most part from concerns with related ownership interests and refinanced. *277 Main Properties, Inc., was a corporation incorporated under the laws of the State of Texas on April 9, 1934, with a capital stock of $ 20,000. At all times during its existence the capital stock of Main Properties, Inc., was $ 20,000, and Main Properties, Inc., was a wholly owned subsidiary of Realty Management Corporation. Lamar Properties, Inc., was a corporation incorporated under the laws of the State of Texas on January 30, 1934, with a capital stock of $ 10,000. At all times during its existence the capital stock of Lamar Properties, Inc., was $ 10,000, and Lamar Properties, Inc., was a wholly owned subsidiary of Realty Investment Corporation. The Commerce Company was a corporation incorporated under the laws of the State of Texas on October 8, 1936. Its entire capital stock was owned by Jesse H. Jones. The Commerce Company was the successor through a reorganization of the Jesse H. Jones Company, *1368 all the stock of which was owned by Jesse H. Jones. The Commerce Company was succeeded by Commerce Company which was incorporated on January 2, 1938. Block One Thirty-Nine, Inc., Commerce Company, The Fair Building Company, Goggan Properties, Inc., Southern Loan & Investment*278 Company, Texas Building Company, Peer Properties, Inc., Nine Hundred Main, Inc., Phoenix Corporation, Seven Hundred Main, Inc., Rice Properties, Inc., Electric Properties, Inc., Mason Block Realty Company, Block Eighty-Nine, Inc., H. & D. Corporation, Worth Properties, Inc., Main Properties, Inc., and Lamar Properties, Inc., were all real estate corporations holding title to properties in and around Houston, Texas, at some time or continuously from 1935 through 1943, and were all controlled by the Jesse H. Jones interests. Petitioner's funds to purchase its assets came from invested capital, accumulated earnings and profits, and loans. At all times since its incorporation petitioner's capital stock has remained at $ 1,000, divided into 100 shares. Petitioner on its excess profits tax returns reported the following accumulated earnings and profits: February 28, 1943 $ 175,390.90 February 29, 1944 179,204.45 February 28, 1945 177,680.86 March 1 to December 31, 1945 171,392.23 Petitioner obtained a long term loan commitment from the Equitable Life Assurance Company of the United States totaling $ 4,170,000, which was to bear 4 per cent interest and to be secured by deeds*279 of trust covering the aforesaid properties owned by petitioner, covering all the properties except the Kirby Theatre and leasehold. Of the $ 4,170,000, $ 390,000 was to be used for the sole purpose of air conditioning and rehabilitating certain of the properties. During the period from April 23, 1941, through January 12, 1942, Realty Management Company made loans to petitioner totaling $ 484,000. Petitioner is a domestic corporation not in existence before January 1, 1940, which computed its excess profits credit on the invested capital method. After the other issues in these proceedings were settled, the excess profits credits were computed in the Conference Settlement Reports as follows: March 1 to [1945] December 31, [1945] Average equity invested capital ($ 1,000 capital stock plus accumulated earnings and profits) $ 4,949.50 $ 83,788.45 $ 195,482.87 $ 334,138.12 Average borrowed invested capital * (50% of average borrowed capital) 2,113,961.50 2,078,749.32 1,950,296.58 1,820,270.90 Total invested capital allowed $ 2,118,911.00 $ 2,162,537.77 $ 2,145,779.45 $ 2,154,409.02 Excess profits credit, 8% of invested capital $ 169,512.88 $ 173,003.02 $ 171,662.36 $ 172,352.72 *280 *1369 The amounts of income and excess profits taxes which petitioner has paid in each of the taxable years have been stipulated and need not be set out in detail here. OPINION. The only question presented in these proceedings is whether petitioner is entitled to any relief from excess profits taxes under section 722 (c) (3) of the Internal Revenue Code for the fiscal years ended February 28, 1943, 1944, and 1945, and for the tax period from March 1, to December 31, 1945. The applicable statute is printed in the margin. 2 *281 It will be noted that section 722 (c) provides three grounds for relief. Petitioner does not claim that section 722 (c) (1) and (2) have any application. Petitioner claims that under section 722 (c) (3) its tax is excessive and discriminatory because its invested capital is abnormally low. If a taxpayer corporation qualifies for relief under section 722 (c) (3), it must establish constructive average base period net earnings under section 722 (a). Thus, while grounds for relief are all concerned with invested capital the manner of computing relief is basically the same as under section 722 (b). At the beginning of this discussion it should be pointed out that it is not enough for a taxpayer corporation to prove that it is entitled to relief under one of the three grounds specified under section 722 (c). It must go further and establish a constructive average base period net income which will give it a larger excess profits credit than is given under the invested capital method. In discussing section 722 (c) in Danco Co., 14 T. C. 276, this Court stated: [At p. 282] The existence of one of the qualifying conditions specified in the statute is not*282 sufficient to establish a taxpayer's right to relief under section 722 (c), for the reason that the condition may not result in the invested capital method being an inadequate standard for the determination of the excess profits credit or because it may be more than outweighed by other unusual war conditions operating to the taxpayer's advantage during the taxable years. Therefore, the taxpayer must demonstrate the inadequacy of its excess profits credit based *1370 on invested capital by showing that the inadequacy results from one of the above factors and by establishing within the framework of section 722 (a) a fair and just amount representing normal earnings to be used as a constructive average base period net income. [At p. 287] As we have previously pointed out, the mere existence of the qualifying features of section 722 (c) does not establish a taxpayer's right to relief. The petitioner must further demonstrate the inadequacy of its excess profits credit based upon invested capital by establishing under section 722 (a) a fair and just amount representing normal earnings to be used as a constructive average base period net income. Cf. Lamar Creamery Co., 8 T. C. 928;*283 Irwin B. Schwabe Co., 12 T. C. 606. For the purpose of a decision in the instant case we will assume that petitioner has proved its ground under section 722 (c) (3). But has it established a constructive average base period net income which will give it a larger excess profits credit than the Commissioner has allowed under the invested capital method? We do not think petitioner has met its burden of proof in this respect, even if we assume that petitioner has established as large a constructive average base period net income as it now claims in its briefs, namely, $ 176,555.89. Respondent contends that under petitioner's evidence it has not established any constructive average base period net income at all. When this case was called after being set on the Galveston Calendar, petitioner was granted motions to file amendments to its petitions. It attached Forms 991 entitled "Amended Applications for Relief." On these documents the petitioner wishes to increase its claim for constructive average base period net income from $ 176,555.89 to $ 482,672.50, due to an alleged increase in the constructive base period normal net income of the Lamar Hotel. *284 Petitioner claimed for the first time that this increase should be allowed because the profit cycle of the hotel industry, to which industry the Lamar Hotel belonged, was substantially different in length and amplitude from the profits cycle of general business. These facts were not presented early enough to be acted upon by the Commissioner. This would be contrary to the principle underlying our holding in Blum Folding Paper Box Co., 4 T. C. 795. In the Blum Folding Paper Box Co. case we said: The scheme of the statute is that applications for relief under section 722 are to be presented in full to the Commissioner, who handles them administratively and passes upon them in the first instance in an effort to settle them without suit. This means that the applications must set forth not only the grounds for relief, but also a statement of the facts which the Commissioner is to consider in support of the reasons given. Additions are made by amendments before the claim is acted upon by the Commissioner. The Tax Court merely reviews his final determination. See sec. 732 (a), I. R. C. The taxpayer may not, as here, file a superficial claim, leaving*285 the Commissioner in ignorance *1371 of the possible factual support for the claim, and then, after the resulting disallowance, come forward for the first time with the supporting statement of facts. That information is not a part of the application and consideration of it is beyond the scope of review by the Tax Court. [Emphasis added.] Furthermore, in its brief and reply brief, petitioner appears to abandon the argument about the profit cycle of the hotel industry as covered by the amendments to its petitions. It now contends that the fair and just amount to be used as a constructive average base period net income for petitioner should be $ 176,555.89, the same as claimed in its original applications for relief and which would give an excess profits credit of $ 167,728.10. This proposed credit is smaller than the excess profits credits under the invested capital method computed on petitioner's tax returns and determined by respondent: Credits on Credit petitioner's determined by Year ended tax returns respondent February 28, 1943 $ 175,390.90 $ 169,512.88 February 29, 1944 179,204.45 173,003.02 February 28, 1945 177,680.86 171,662.36 March 1 to December 31, 1945 171,392.23 172,352.72 *286 As we have already pointed out, section 722 (c) provides that the tax "shall be considered to be excessive and discriminatory * * * if the excess profits credit based on invested capital is an inadequate standard for determining excess profits" due to one of three statutory conditions. What petitioner really is objecting to as we construe the argument contained in its brief, is not the inadequacy of the excess profits credit under the invested capital method, but the statutory treatment of interest. Section 711 (a) (2) (B) provides that under the invested capital method the deduction for interest shall be reduced by 50 per cent of certain interest payments in computing excess profits net income. 3 Under the income method no such adjustment is made for interest in computing excess profits net income in section 711 (a) (1), but the interest expenses as deductions reduce average base period net *1372 income. Moreover, section 719 provides that 50 per cent of the average borrowed capital shall be part of invested capital. That is a statutory right to which petitioner is entitled and in the computation of petitioner's excess profits credit for each of the taxable years, the Commissioner*287 has observed this statutory requirement. The petitioner does not contend otherwise. As an illustration which shows that what petitioner is really objecting to is the statutory treatment of interest as required by section 711 (a) (2) (B), we quote from its brief, as follows: The effective excess profits credit based on borrowed capital is arrived at as follows: 1. Excess Profits Credit, 8% of invested capital of $ 2,118,911.00 (per Respondent's deficiency Notice of Computation for the fiscal year ended February 28, 1943) $ 169,512.88 2. Deduct Excess Profits Credit based on average equity invested capital, 8% of $ 4,949.50 395.96 3. Excess Profits Credit based on borrowed capital, 8% of $ 2,113,961.50 $ 169,116.92 4. Deduct 50% of interest on borrowed capital which must be arbitrarily added to Petitioner's actual net income when Excess Profits credit based on invested capital is used 86,943.26 5. Effective Excess Profits Credit based on borrowed capital $ 82,173.66 The excess profits credit actually allowed Petitioner on its borrowed capital is thus only 1.944% of Petitioner's total average borrowed capital of $ 4,227,923.00 as compared*288 with 8% excess profits credit allowed on equity capital. There is no such thing in the statute as petitioner terms in (5) above "Effective Excess Profits Credit based on borrowed capital $ 82,173.66." Respondent in his computation of petitioner's excess profits credit*289 has used no such method. The respondent in Docket No. 10925 for the fiscal year ending February 28, 1943, has computed petitioner's excess profits credit based on invested capital as follows: Excess Profits Credit -- Based on Invested Capital Invested Capital As corrected Average equity invested capital $ 4,949.50 Average borrowed invested capital 2,113,961.50 Average invested capital $ 2,118,911.00 Invested capital $ 2,118,911.00 Excess Profits Credit Excess Profits Credit, 8% of $ 2,118,911.00 invested capital $ 169,512.88 *1373 Respondent has made similar computations except as to amounts for the other taxable years and we hold that in doing so he has followed the statute. There is no warrant in law for petitioner's contention that respondent's method results in an "Effective Excess Profits Credit" of $ 82,173.66 based on borrowed capital, instead of excess profits credit of $ 169,116.92 based on borrowed capital which respondent has allowed. Whereas section 722 (c) gives relief for taxpayers not entitled to use the income method, section 722 (b) applies to taxpayers entitled to use the income method. Section 722 (b) gives relief where the*290 "average base period net income is an inadequate standard." A constructive average base period net income in excess of the average base period net income is an essential element in computing the excess profits credit under the income method in section 713. In Tober-Saifer Shoe Manufacturing Co., 17 T. C. 1042, excess profits tax relief under section 722 (b) was denied and the Court said: The petitioner must reconstruct an average base period net income of more than $ 40,184.41 [the amount computed without the benefit of section 722], otherwise it would not be shown that its "average base period net income does not reflect the normal operation for the entire base period of the business." See also Lamport Co., 17 T. C. 1079. In Monarch Cap Screw & Manufacturing Co., 5 T. C. 1220, 1227, which arose under section 722 (b), this Court said that the general purpose of section 722 is to increase the excess profits credit: Section 722 is a general relief measure. Its purpose is to "afford relief in meritorious cases to corporations which bear an excessive tax burden because of an abnormally low *291 excess profits credit." (Senate Finance Committee, Rept. No. 1631, 77th Cong., 2d Sess.) The plan of the statute is to bring about an increase in such cases, in the statutory excess profits credit. * * * In other cases, relief under section 722 has been limited to its specific terms of using "constructive average base period net income in lieu of the average base period net income" in computing the excess profits credit and has not been construed loosely as additional relief. The provisions of section 713 (e) raising the excess profit net income of the lowest base period year to 75 per cent of the average for the other years were not applicable in determining relief under section 722 in Stimson Mill Co., 7 T. C. 1065, affd. 163 F. 2d 269, where this Court said: [At p. 1068] The present controversy, under the above facts, is principally concerned with the application of those factors prescribed by the Internal Revenue Code by means of which a corporation may obtain a greater "credit" for *1374 excess profits tax purposes than the one to which it would ordinarily be entitled by reason of the actual net earnings of the business*292 in the base-period years 1936 through 1939. * * * [At p. 1071] * * * Thus we have, by statutory definition, traced through all its stages, seen that nowhere in the determination of the "excess profits net income," which, and which only, is to be computed in the aggregate for four years, under section 713 (e) (1), can section 722 be utilized or included. * * * See also Dowd-Feder, Inc., 10 T. C. 345, affd. 173 F. 2d 673; and Homer Laughlin China Co., 7 T. C. 1325. Petitioner's proposed credit under section 722 based on a constructive average base period net income argued for in petitioner's brief, but which respondent contends petitioner has not proved, is smaller than the credits determined by the respondent and petitioner's returns based on invested capital. Its use, so far as we can see, would not afford petitioner any relief. Respondent's denial of relief to petitioner under section 722 is sustained. Decisions will be entered under Rule 50. Footnotes 1. Petitioner purchased the Lamar Hotel and Metropolitan Theatre located in Block One Thirty-Nine from Lamar Properties, Inc., also a wholly owned subsidiary of Realty Management Company for $ 1,596,195.02. Petitioner purchased from Main Properties, Inc., another wholly owned subsidiary of Realty Management Company, the Kirby Building and fee in Block One Thirty-seven, the National Standard Building, Loew's State Theatre, the Lamar Annex Hotel, and the leasehold to the north one-half in Block One Thirty-nine for $ 998,476.14. Through Main and McKinney Building Company petitioner exercised an option to purchase the fee covered by the lease of the north one-half of Block One Thirty-nine from the Settegast's, apparently an unrelated interest, for $ 700,000. The H. & D. Corporation, a subsidiary of the Commerce Company, which had related stockholding interests with Realty Management Company, conveyed to petitioner the fee interest in the south one-half of Block One Thirty-nine for $ 505,000. Petitioner purchased the Kirby Theatre located in Block One Thirty-seven for $ 78,849.17 from Rice Properties, Inc., and Southern Loan & Investment Co., both companies having interests related to petitioner.↩ *. These figures corresponded exactly to petitioner's tax returns, except for the year ended 1943 petitioner's figure was $ 2,113,298.50.↩ 2. Sec. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME. * * * * (c) Invested Capital Corporations, Etc. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer, not entitled to use the excess profits credit based on income pursuant to section 713, if the excess profits credit based on invested capital is an inadequate standard for determining excess profits, because -- (1) the business of the taxpayer is of a class in which intangible assets not includible in invested capital under section 718 make important contributions to income, (2) the business of the taxpayer is of a class in which capital is not an important income-producing factor, or (3) the invested capital of the taxpayer is abnormally low.↩ In such case for the purposes of this subchapter, such taxpayer shall be considered to be entitled to use the excess profits credit based on income, using the constructive average base period net income determined under subsection (a). * * * 3. Sec. 711. EXCESS PROFITS NET INCOME. (a) Taxable Years Beginning after December 31, 1939. -- The excess profits net income for any taxable year beginning after December 31, 1939, shall be the normal-tax net income, as defined in section 13 (a) (2), for such year except that the following adjustments shall be made: * * * * (2) Excess profits credit computed under invested capital credit. -- If the excess profits credit is computed under section 714, the adjustments shall be as follows: * * * * (B) Interest. -- The deduction for interest shall be reduced by an amount equal to 50 per centum of so much of such interest as represents interest on the indebtedness included in the daily amounts of borrowed capital (determined under section 719 (a));↩