George W. Caswell Co. v. Commissioner

GEORGE W. CASWELL CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. George W. Caswell Co. v. Commissioner Docket No. 13878. United States Board of Tax Appeals 14 B.T.A. 15; 1928 BTA LEXIS 3043; November 6, 1928, Promulgated *3043 SPECIAL ASSESSMENT. - Prior to the taxable year the petitioner expended large sums of money in the development and extension of trade routes, acquiring trade-marks, and for advertising special brands of merchandise, all of which expenditures were concurrently charged to operating expense. Some portion of said expenditures constituted capital investment, the balance being properly chargeable to expense, but the portion allocable to capital can not now be determined. Said expenditures materially contributed to the production of the taxable income. Held, that said facts bring petitioner within the scope of section 327(a) of the Revenue Act of 1921. W. W. Spalding, Esq., for the petitioner. Brice Toole, Esq., for the respondent. TRAMMELL *15 This is a proceeding for the redetermination of a deficiency in income and profits taxes for the calendar year 1921 in the amount of $1,810.02. In the petition, redetermination of a deficiency for 1920 in the amount of $2,805.88 was also sought, but the appeal, in so far as it involved the deficiency for said last named year, has been abandoned, and the only issue now presented for consideration is*3044 whether the petitioner is entitled to special assessment of its profits tax for 1921 under the provisions of sections 327 and 328 of the Revenue Act of that year. FINDINGS OF FACT. Petitioner is a California corporation, with its principal office at San Francisco. It was organized February 2, 1901, and since incorporation has been engaged in the business of importing, blending, roasting and grinding coffees, importing and blending teas, manufacturing baking powder and flavoring extracts, and handling spices and olive oil. *16 During the years prior to the taxable year, the petitioner made large expenditures for the purpose of acquiring and developing trade-marks and trade-brands, which expenditures were not capitalized on the books, but were charged to operating expense. During the years 1906 to 1920, both inclusive, the petitioner made cash expenditures for route extensions and advertising special brands of merchandise in the total amount of $294,539.47, which was charged to operating expense. During the years 1904, 1905, and that part of 1906 prior to April 18, the petitioner made cash expenditures for route extensions and advertising special brands of merchandise*3045 in the total amount of $20,549.51, no part of which was set up on its books as a capital asset. The principal trade-marks or trade-brands of coffee, used by the petitioner during the taxable year and prior thereto, were "National Crest," "Caswell Blend," "Yellow and Blue," "Kona," and "Incomparable Urn." The principal brands used for teas were "Caswell's Afternoon Tea" and "Tea Chest," and for spices, "Caswell Blend." The latter brand was also used for baking powder and flavoring extracts. Prior to 1920 "Caswell Blend" was called "California Blend." The name of the brand was changed in order to give it a greater distribution. There was some objection to the "California Blend" outside of the State of California, and the name was changed to "Caswell Blend" in 1920. The petitioner has used these brands continuously since the respective dates of their registration, as follows: The trade-mark "National Crest" was filed in the office of the Secretary of State of the State of California on June 5, 1907; the trade-mark "California Blend" was filed in the office of the said Secretary of State on March 25, 1909; the trade-mark "Urn" was filed in the office of said Secretary of State*3046 on March 3, 1911; on September 2, 1913, the petitioner registered its "Tea Chest" brand in the United States Patent Office, and on January 6, 1920, the petitioner registered "The Caswell Blend" (for coffee) in the United States Patent Office. About the year 1901, the petitioner acquired from the Lievre Fricke Co. the brands "Turco," "Red Seal," and "Mountaineer." During the taxable year 1921 approximately 84 per cent of the petitioner's total coffee sales was made under said brands. The expenditures made by the petitioner for advertising its special brands, for route extensions in the city and country, and bonuses paid to city customers all served materially to increase its brand sales. The petitioner's gross sales (less goods returned) for 1921 were $1,192,971.48, of which approximately $974,077.48 represented brand *17 sales. The petitioner's gross sales (less goods returned) for 1909 were $238,244.53, of which approximately the amount of $158,973.80 represented brand sales. The petitioner's gross sales for 1916 amounted to $384,479.53; for 1917, $459,047.47; and for 1918, $553,024.55. The books and records kept by the petitioner prior to 1906 were destroyed in*3047 the San Francisco fire of April, 1906. Immediately subsequent to said fire, the petitioner opened a new set of books and in the opening trial balance no item was included in the assets as representing prior expenditures for advertising or developing special brands or sales routes. OPINION. TRAMMELL: This proceeding originally involved deficiencies in income and profits taxes for the years 1920 and 1921, one issue only being raised with respect to the deficiency asserted for each of said years. On motion of the respondent, duly made and granted without objection by the petitioner, the hearing herein was confined to the issue defined in Rule 62(b) with respect to the deficiency for 1921, the issue relating to the deficiency for the year 1920 having been abandoned. The sole remaining issue presented for consideration is whether the petitioner is entitled to special assessment of its profits tax for the calendar year 1921 under the provisions of sections 327 and 328 of the Revenue Act of that year. At the hearing its was stipulated that the respondent denied special assessment of the petitioner's profits tax for said year, and this fact is further established by affirmative*3048 allegation in the petition and admission in the answer. The Revenue Act of 1921 provides in material part as follows: SEC. 327. That in the following cases the tax shall be determined as provided in section 328: (a) Where the Commissioner is unable to determine the invested capital as provided in section 326. The evidence adduced by the petitioner shows that it was organized in 1901 to carry on the business of importing, blending, roasting, and grinding coffees, importing and blending teas, manufacturing baking powders and flavoring extracts, and handling spices and olive oil. Shortly after its incorporation, the petitioner acquired from another company three established brands known as "Turco," "Red Seal," and "Mountaineer." It thereafter registered other trade-marks or special brands for its products, as set forth in our findings of fact, and expended large sums of money in advertising and creating a market for said brands, and in the establishment and extension of sales routes. During the years from 1906 to 1920, inclusive, the petitioner expended the aggregate amount *18 of $294,539.47 for route extensions and advertising special brands and creating new markets, *3049 all of which was charged to expense. Largely as a result of its advertising expenditures, the petitioner's brand sales increased from $158,973.80 in 1909 to $974,077.48 in the taxable year 1921. In 1909 the petitioner's brand sales constituted approximately 66 per cent of its gross sales, whereas in 1921 approximately 84 per cent of its gross sales were made under its special brands. It is apparent, therefore, that to a substantial extent the income derived by the petitioner in the taxable year is attributable to its prior advertising expenditures. Sums expended by a corporation in advertising its products, designed to aid promotion and effect expansion of its business, undoubtedly constitute in material part a capital investment. It is equally true, however, that some part of such expenditures must be regarded as the cost of maintenance and hence not a capital investment but an operating expense properly chargeable against current income. Where no reasonable basis is established for the allocation of such expenditures between capital and expense, no part thereof may be included in invested capital. *3050 ; . The expenditures of the petitioner herein constituted to a substantial extent investments in capital assets which have not been and can not be included in invested capital, but which nevertheless contributed materially to the production of the taxable income. This is strikingly shown by the rapid increase in the petitioner's brand sales, which in 1921 constituted 84 per cent of its gross sales. In , we expressed the view that advertising expenditures comprising a campaign or system of promotion might in part be of permanent significance and properly regarded as a capital investment, but we held that where no reasonable basis was presented upon which an allocation could be predicated, no part of such expenditures could be capitalized, and in that connection, we said: The impossibility of finding the portion to be capitalized brings the case squarely within section 327, Revenue Act of 1918, * * * In our opinion, therefore, the facts in the present case bring the petitioner within the scope of section 327(a) of the Revenue*3051 Act of 1921, supra, and entitle it to have its tax determined in accordance with the provisions of section 328 of said Act, upon the ground that its invested capital can not be determined as provided in section 326. Reviewed by the Board. Judgment will be entered under Rule 62(c).