Duquesne Steel Foundry Co. v. Commissioner

DUQUESNE STEEL FOUNDRY CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Duquesne Steel Foundry Co. v. Commissioner Docket No. 5217. United States Board of Tax Appeals 15 B.T.A. 467; 1929 BTA LEXIS 2857; February 15, 1929, Promulgated *2857 Special assessment denied. William F. Knox, Esq., for the petitioner. J. L. Backstrom, Esq., for the respondent. VAN FOSSAN *467 This proceeding is brought to redetermine the income and profits taxes of the petitioner for the year 1917, as to which year respondent has asserted a deficiency in the amount of $9,500.75. The petitioner alleges that the respondent erred in refusing to determine such taxes under the provisions of section 210 of the Revenue Act of 1917. In support of that allegation petitioner asserts that it is entitled to special assessment because of abnormal conditions affecting its capital and income; specifically, its ultra-conservative business policy and the accounting methods in effect throughout the years preceding the taxable year. Under Rule 62 the evidence presented at the hearing on March 27, 1928, was limited in the first instance to the question as to whether or not the petitioner was entitled to special assessment under the provisions of the said section 210. FINDINGS OF FACT. The petitioner is a corporation organized under the laws of the State of Pennsylvania in 1899. Its stock is closely held, there being*2858 but nine stockholders, two of whom, William A. Herron and Thomas H. Bakewell, owned 80 per cent thereof. It is engaged in the business of manufacturing and selling steel castings and operates its plant near Coraopolis, Pa. In its manufacturing processes the petitioner was required to expend large sums in purchasing and building patterns, flasks and other equipment. During the fall of 1903 the board of directors of the petitioner determined that thereafter the capital accounts relating to flasks and patterns be considered as "complete" and that further expenditures on such accounts be treated as expense. On September 1, 1903, the capital pattern account was reduced from $7,352.97 to $7,000, while its capital flask account was reduced from $46,550.80 to $40,000, both accounts remaining at such figures through December 31, 1917. During the period extending from 1904 to 1917, inclusive, the petitioner manufactured some of its own patterns and purchased others. The proportion of purchases was estimated to be about 20 per cent. The petitioner produced no records showing the number and cost of the patterns and flasks owned by it on December 31, 1917. On November 20, 1922, a fire occurred*2859 in the petitioner's plant, destroying a large number of patterns and *468 records relating thereto. All patterns on hand in 1917 were potentially usable, although some of them were very rarely, if ever, required. All labor, material and a portion of the overhead costs required in the manufacture of the patterns were charged to expense. Likewise the cost of labor and materials used in the manufacture of flasks was charged to expense. Over 4,200 patterns and over 2,000 tons of flasks were estimated to be on hand on December 31, 1917. The life of a flask was said to be between ten and fifteen years. One witness estimated the value of patterns on December 31, 1917, to be from $180,000 to $200,000, while another estimated that they cost in the neighborhood of $250,000. The same witnesses estimated the value of the flasks on that date to be in excess of $100,000. In 1913 two crane runways and a crane were constructed at an estimated cost of from $8,000 to $12,000. A large portion of this amount was charged to expense under material and labor accounts and was not debited to the capital account. Customarily the petitioner charged to expense the cost of additions to its plant*2860 under $1,000, but no evidence was presented showing the number, character or extent of such plant additions. OPINION. VAN FOSSAN: The issue in this case is confined solely to the question whether or not the petitioner is entitled to special assessment under the provisions of section 210 of the Revenue Act of 1917 and the regulations established thereunder. Section 210 provides: That if the Secretary of the Treasury is unable in any case satisfactorily to determine the invested capital, and the amount of the deduction shall be the sum of (1) an amount equal to the same proportion of the net income of the trade or business received during the taxable year as the proportion which the average deduction (determined in the same manner as provided in section two hundred and three, without including the $3,000 or $6,000 therein referred to) for the same calendar year of representative corporations, partnerships, and individuals, engaged in a like or similar trade or business, bears to the total net income of the trade or business received by such corporations, partnerships, and individuals, plus (2) in the case of a domestic corporation $3,000, and in the case of a domestic partnership*2861 or a citizen or resident of the United States $6,000. For the purpose of this section the proportion between the deduction and the net income in each trade or business shall be determined by the Commissioner or Internal Revenue in accordance with regulations prescribed by him, with the approval of the Secretary of the Treasury. In the case of a corporation or partnership which has fixed its own fiscal year, the proportion determined for the calendar year ending during such fiscal year shall be used. The pertinent provisions of article 52, Regulations 41, are as follows: Section 210 provides for exceptional cases in which the invested capital can not be satisfactorily determined. In such cases the taxpayer may submit to *469 the Commissioner of Internal Revenue evidence in support of a claim for assessment under the provisions of section 210. (See articles 18 and 24.) Such exceptional cases may consist, among others, of the following: (1) Where, through defective accounting or the lack of adequate data, it is impossible accurately to compute invested capital. * * * (3) Long-established business concerns which by reason of ultra-conservative accounting or the*2862 form and manner of their organization would, through the operation of section 207, be placed at a serious disadvantage in competing with representative concerns in a like or similar trade or business. Referring to section 210 of the Revenue Act of 1917, we said in : This section provides only one ground for special relief, namely, "if the Secretary of the Treasury is unable satisfactorily to determine the invested capital." The invested capital of the taxpayer, based on the January 1, 1914, value of its assets, has been determined and was not attacked upon the hearing before the Board. There is nothing in the history relating to this section to which our attention has been called, or which we have been able to find, which would extend the scope of this section beyond its words. It is true, as pointed out by counsel for the taxpayer, that the Commissioner found it impracticable to follow the section literally and laid down regulations which broadened its scope, and that this was done with the implied consent of Congress, but the taxpayer has not, in our opinion, brought itself within any of the classes mentioned within*2863 the regulations. The same observations may pertinently be made as to the case at bar. Petitioner alleges that the cost of manufacture and purchase of certain patterns, flasks and other equipment for a long period of years was treasted as an item of expense rather than of invested capital and that such an ultra-conservative business policy and accounting method constituted an abnormal condition entitling it to special assessment under section 210 and article 52, Regulations 41. Whether such items should be charged to capital account or to expense is a question on which opinion might easily differ. Many patterns and flasks are specially constructed for single orders and perhaps never again used, others might be used on re-orders. In such a situation proper accounting might amply justify the treatment of such expenditures as a charge to expense rather than to capital account. Cf. ; ; and . Petitioner's own practice of charging these items to expense rather than capital account creates a reasonable inference that it deemed*2864 them more properly to be so charged. So far as the record shows this may be the general accounting practice in the industry. Petitioner did not prove it to be exceptional. In any event the record is wholly insufficient to enable us to hold that the respondent is unable satisfactorily to determine petitioner's invested capital. No proof was submitted of the amount of invested *470 capital allowed by respondent nor of the items or basis used in his computation. For aught that appears the respondent may have made due and proper allowance for the alleged infirmities of petitioner's accounting methods and records. Such matters are essential items of proof and can not be left to inference or conjecture. The presumption of correctness attaching to the respondent's finding must be overcome by proof of such a character as will enable us definitely to say that respondent has erred. Petitioner having failed to furnish such proof, the finding of the respondent will not be disturbed. Judgment will be entered for the respondent.