Acme Manifolding Co. v. Commissioner

ACME MANIFOLDING COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Acme Manifolding Co. v. Commissioner Docket Nos. 25194, 38687. United States Board of Tax Appeals 24 B.T.A. 429; 1931 BTA LEXIS 1641; October 23, 1931, Promulgated *1641 1. Actual cash value of property acquired for cash and stock determined, and held that in computing invested capital the cash paid is to be allocated to the tangibles, and the stock to the tangibles in excess of the cash and to the intangibles in accordance with the rules announced in Evansville Courier,23 B.T.A. 862, and St. Louis Screw Co.,2 B.T.A. 649. 2. Respondent's finding of the current earnings available for the payment of dividends sustained in the absence of evidence proving the determination to be erroneous. 3. Special assessment denied. 4. Respondent's allowance for depreciation on machinery, furniture and fixtures at a composite rate not shown to be unreasonable. Morris Metz, C.P.A., for the petitioner. Harold Allen, Esq., and L. H. Rushbrook, Esq., for the respondent. ARUNDELL *429 These proceedings are for the redetermination of deficiencies of $3,548.04 and $1,445.18 in income and profits taxes for the respective fiscal years ended August 31, 1920, and August 31, 1921, and deficiencies of $908.67, $614.38 and $506.09, in income taxes for the fiscal years ended August 31, 1924, 1925*1642 and 1926, respectively. On motion of the respondent and without objection by petitioner, the proceedings were dismissed in so far as they relate to 1919, no deficiency having been asserted for that year. The issues not abandoned *430 are: 1920 and 1921 - (1) whether invested capital should be increased; (2) whether the apportionment made for dividends paid out of current earnings is correct; (3) whether due to abnormalities the tax should be computed under section 328. All years - whether the allowances made for depreciation are reasonable. FINDINGS OF FACT. The petitioner, a New York corporation, organized in May, 1914, with an authorized capital stock of $10,000, consisting of 100 shares of the par value of $100 each, is successor to the business of a partnership which, since 1899, had been engaged in the manufacturing of manifold books and systems, carbon papers and kindred products, under the firm name of Acme Manifolding Company. At a meeting of the incorporators of the petitioner on June 17, 1914, a resolution was adopted setting forth that the two members of the partnership "are the owners of the entire plant with machinery, stock on hand, bills and accounts*1643 receivable, amounting in cost value as estimated to $10,000" and are willing to sell the said properties "in consideration of the issuance to them of 98 shares of the capital stock of this company at the par value of $9,800"; that the said partners "estimate the good will of the business to be reasonably worth the sum of $50,000"; that the said partners desire that said properties, together with the good will and the right to use the name Acme Manifolding Company, "be accepted in full payment of their said subscription to stock of the par value of $9,800 and the sum of $50,000, with interest to be paid * * * out of the net earnings of the corporation as they may accrue and be available for that purpose"; and that it appears to the stockholders that the said properties, including good will and trade name, "constitute a fair and adequate consideration for the issuance * * * of 98 shares of the capital stock of this company * * * and the sum of $50,000, with interest to be paid out of the net earnings of the corporation as they may accrue and be available for that purpose." The 98 shares of stock were issued in accordance with this resolution and the $50,000 to be paid the partners out*1644 of the future earnings of the corporation was paid by the petitioner prior to the taxable years under consideration. It further appears that the petitioner gave its promissory note to the partners, in the principal sum of $10,120.57, for the amount of cash on hand at the date of transfer of the assets. At the date of transfer the net tangible assets, exclusive of cash, were carried on the partnership books at a value of $76,393.44, which included plant at a value of $50,008.50. In recording the acquisition of the assets on its books, the petitioner entered the plant and good will thereon at the values of $50,000 and $118.74, respectively. *431 In computing invested capital for the fiscal years 1920 and 1921 the respondent included therein a paid-in value for the plant of $50,000, but failed to include any value whatever for good will. The actual cash values of the plant and good will acquired by the petitioner from its predecessor partnership were, as of the date of acquisition, $92,079.50 and $50,000, respectively. In his computation of petitioner's invested capital for the fiscal years ended in 1920 and 1921, respondent, in determining the amount of dividends paid*1645 on December 31, 1919, and December 31, 1920, out of surplus, prorated the earnings ratably over the year. The employees of petitioner were on a strike for a period of eight weeks in July and August, 1919. During the strike the most important orders on hand were filled by petitioner's officers and plant foreman. The unfilled orders were filled during the next fiscal year. Such orders amounted to about $75,000. Petitioner owned and used in 1924, 1925 and 1926, in the operation of its plant, various kinds of printing presses, perforating, ruling and numbering machines, and other machinery and equipment necessary for the conduct of its business. In those years petitioner operated its plant in excess of eight hours per day two days each week. OPINION. ARUNDELL: The principal invested capital issue is whether certain assets acquired by the petitioner from the predecessor partnership have been included in invested capital at the full amount allowed by the statute. Good will is sought to be included at $50,000, this being the amount which the petitioner says it agreed to pay and did pay therefor in cash. An actual cash value of $92,079.50 is claimed for the plant at the date*1646 of acquisition, which is $42,079.50 greater than the value recorded on the books and allowed by the respondent. The right of the petitioner to include in invested capital the remaining tangibles acquired from the partnership, at the net value carried on the partnership books, $26,384.94, is not in question. We are unable to agree with petitioner's contention that the tangible property and good will were acquired separately. At the first meeting of the stockholders on June 17, 1914, the directors were authorized to acquire the partnership "plant and machinery, stock on hand, bills and accounts receivable, good will and trade name" for 98 shares of stock and $50,000 to be paid "out of the net earnings of the corporation as they may accrue and the available for that purpose." At the directors' meeting on the same day it was resolved that the "machinery, stock on hand, bills and accounts receivable, and name are of the value of at least $59,800." The bill of sale recited that the partners sold to the petitioner the partnership business *432 "together with machinery, stock on hand, bills and accounts receivable, good will and all the right to use the name Acme Manifolding Co. *1647 " The only hint at any segregation of tangibles from intangibles is in the minutes of the first meeting of the incorporators of petitioner, where it is recited that the partners "estimate the good will of said business to be reasonably worth the sum of $50,000." All of the evidence indicates that the partners desired merely to incorporate their business in such a way as to retain control and to realize $50,000 out the earnings and without any thought of segregating tangibles from intangibles. When they came to record the transaction on the books no record was made which would substantiate the claim now advanced. An item of $118.74 was entered which was designated "Good Will," but even that amount appears to be merely a balancing entry made to reflect the difference between the partners' capital account and the petitioner's liability to the partners, rather than an entry to actually reflect good will. For the year 1920 respondent computed invested capital at $141,826.41. This sum included $50,000 as representing the value of the plant acquired from the partnership, adjusted to date to reflect subsequent additions and depreciation reserve. For the year 1921 the invested capital*1648 allowed by the respondent was $128,871.66, which included the plant at the same figure as for 1920, with similar adjustments for additions and depreciation. In neither year has the respondent allowed any value for good will. We think the evidence warrants an increase in petitioner's invested capital. A very careful inventory was prepared of the articles and equipment going to make up petitioner's plant account at the time of acquisition, which inventory set forth in detail each item with a figure opposite it which the evidence fairly establishes to be depreciated cost, such figure representing the initial cost price deprecisted at the rate of 10 per cent per year. If this were the only evidence it probably would not meet the test of the statute, as it is actual cash value of tangible property paid in for stock or shares which is included in invested capital and not depreciated cost. Throughout the examination of witnesses the words "cost" and "value" were loosely used and in this respect the record is somewhat unsatisfactory. However, the cross-examination of petitioner's witness, W. R. Bohmert, served to elicit the opinion that the fair market value of the property in dispute*1649 was roughly $100,000 at the time it was turned over to petitioner. Bohmert had been a partner in the business from its beginning and we are perfectly satisfied of his qualifications to express an opinion of value. We have reached the conclusion that the actual cash value of the plant at the time turned in to petitioner was $92,079.50. This amount *433 should be used in determining invested capital instead of the $50,000 allowed by the respondent. We have found as a fact that the good will turned over by the partnership to petitioner in 1914 had an actual cash value of $50,000. Petitioner's predecessor, the Acme Manifolding Company, a partnership, was organized in 1899, with a capital of $2,400. From this humble beginning it had grown so that in 1914 it included amont its customers some of the leading mercantile establishments of New York, including B. Altman, Gimbel Brothers, Jas. McCrery, Saks & Company, and Tiffany & Company, and was supplying 90 per cent of their needs in the line of manifolding books, etc. Its gross sales for the years 1911, 1912 and 1913, the three years immediately preceding the incorporation, were $230,807.58, $255,061.45 and $243,957.14, respectively, *1650 on which the net profits were, respectively, $18,184, $14,992.47 and $21,609.88. Petitioner's witness, Bohmert, whom we have already mentioned, testified to a value of good will in excess of $50,000. In reaching his conclusion he assumed an average value for tangibles used in the business of $80,000, and average earnings of $35,000. His estimate of earnings of $35,000 per year was excessive, as the average for the three years immediately preceding the incorporation was only something over $18,000. The rule of thumb formula used by Bohmert is one that has been frequently employed, and if we adjust the average income to the lower figure which we believe to be correct, the value for the good will set at $50,000 would not be excessive. While we do not base our conclusion on the application of a formula, we are convinced that the partnership had a substantial good will and that the earnings, testimony of Bohmert, and attendant facts justify a value in the amount of $50,000. From the foregoing it is evident that the petitioner acquired a mixed aggregate of tangible and intangible properties for a consideration of $50,000 cash and $9,800 par value of petitioner's capital stock. *1651 The actual cash value of the tangibles was $118,472.94, while the value of the intangibles, consisting only of good will, was $50,000. In order to determine what part of the mixed aggregate was paid in for shares of stock, the amount of the cash consideration must first be applied against the value of the tangible assets. , and cases therein cited. Under this rule we find that tangibles of the value of $68,472.94 and intangibles of the value of $50,000 were paid in for $9,800 par value of petitioner's capital stock. Allocating the issued stock to the two calsses of properties according to the rule announced in , the par value of stock issued for the intangibles amounted to $4,135.96. Twenty-five per cent of the $10,000 *434 par value of petitioner's capital stock outstanding on March 3, 1917, is the lower of the three limitations on intangible values paid in for shares of stock includable in invested capital, under the provisions of sections 326(a)(4) of the Revenue Acts of 1918 and 1921; hence, the maximum amount of good will value which the petitioner is entitled to include*1652 in invested capital for 1920 and 1921, is $2,500. It is alleged that the respondent erred in the apportionment of earnings applicable to dividends paid in 1920 and 1921. The 1918 and 1921 Acts provide in section 201 that, where dividends are paid after the first sixty days of any taxable year, the earnings shall be deemed to have been accumulated ratably during the period from the beginning of the taxable year to the date of distribution if the books do not show such earnings or profits. The respondent's action in spreading the earnings of the taxable years is proper in the absence of evidence of the earnings to the dates of distribution. . To show error in the respondent's method, petitioner offered proof of the gross sales and profits during the years in question and asks us to find that the profits to the dates of payment of the dividends are in the same ratio as profits for the whole year are to the gross sales. Too many other factors enter into the earning of profits for a given period to accept such a method in preference to the statutory plan. There being no proof that the earnings available for dividends were other than*1653 those determined by respondent, his action is sustained. Several grounds are assigned in petitioner's claim for special assessment. The first ground is that invested capital can not be determined because the books do not reflect the true value of tangibles acquired for stock and good will for cash in 1914. The adjustments, which will follow as a result of our decision on the first issue, very largely destroy petitioner's argument in this particular. The second ground is that abnormalities exist because of the strike in 1919 and alleged improper proration of earnings to determine the amount of current profits available for dividends. The only proof made as to the strike is that it continued for eight weeks in July and August, 1919, making it necessary to fill accumulated orders, amounting to $75,000, in the next fiscal year. We do not know whether petitioner made any profit on those orders or how the strike otherwise affected its income, if at all. Not knowing how petitioner's income was affected by the strike, we can not say that it created an abnormality in either capital or income. The argument as to improper proration of earnings is wholly lacking in merit. In his computation*1654 of the deficiencies for the fiscal years ended in 1924, 1925, and 1926, respondent computed exhaustion on petitioner's machinery, equipment, furniture and fixtures at the composite rate *435 of 10 per cent per annum. Without asking for a definite allowance, petitioner claims the allowance is inadequate, the basis for his contention apparently being that the assets were used more than the usual number of working hours per day. No evidence was offered as to the years 1920 and 1921 or concerning the furniture and fixtures. Such evidence as was offered as to the remaining taxable years and assets shows that some of the machinery had a useful life of less than ten years and others a longer life, based on an eight-hour working schedule. There is no testimony as to the average useful life of the assets. A taxpayer is not entitled to a higher composite rate than that allowed by showing that some of the items to which the rate was applied have a shorter life than the average period of usefulness of all the assets. The evidence does not warrant a disturbance of the respondent's allowance. Petitioner also alleged error in disallowing moving expenses. The evidence on this consisted*1655 of testimony that petitioner moved its plant in January, 1926, and some of its equipment was not moved because not adaptable to the new quarters. This meager evidence is insufficient to form the basis of any material findings of fact and likewise insufficient to show error on the part of the respondent. Decision will be entered under Rule 50.