William S. Doig, Inc. v. Commissioner , 13 B.T.A. 256 ( 1928 )

WILLIAM S. DOIG, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

William S. Doig, Inc. v. Commissioner

Docket Nos. 13905, 16312.

United States Board of Tax Appeals

13 B.T.A. 256; 1928 BTA LEXIS 3284;

August 17, 1928, Promulgated

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1. The assessment of taxes for the years 1918 and 1919 is not barred by the statute of limitations.

2. Depreciation rate determined.

Nathan Agar, C.P.A., for the petitioner.

W. F. Gibbs, Esq., for the respondent.

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ARUNDELL

These proceedings, which were consolidated for hearing and decision, involve deficiencies in income and excess-profits taxes for the years 1918, 1919, and 1920, in the respective amounts of $21,960.11, $11,876.77, and $12,107.62. The issue for 1918 and 1919 is whether assessment of the taxes is barred by the statute of limitations, and the issues for the year 1920 are whether respondent erred in:

(a) Figuring depreciation on small tools used in the business at a rate of 10 per cent per annum instead of at the rate of 30 per cent per annum.

(b) Computing depreciation on the petitioner's case hardening plant at the rate of 5 per cent per annum instead of at the rate of 10 per cent per annum.

(c) Allowing depreciation on an iron building costing $4,835.62 at the rate of 2 per cent per annum instead of at the rate of 25 per cent per annum.

(d) Reducing invested capital by the full amount and prorated amount of proposed assessments of additional taxes for the years 1918 and 1919.

In the event its assignment of error for 1919 is not sustained, the petitioner alleges further that error was committed in:

(a) Capitalizing the amount of $3,953.77 in its accounts for drawings, and patterns instead of allowing the total sum as a business expense.

(b) Computing depreciation on small tools at the rate of 10 per cent per annum instead of at the rate of 30 per cent per annum.

(c) Reducing invested capital by $9,280.34, this figure being the prorated amount of a proposed assessment of additional fax for the prior year.

FINDINGS OF FACT.

The petitioner, a New York corporation, with principal offices at 54 Franklin Street, Brooklyn, is engaged in the business of manufacturing box nailing machines. It was organized April 1, 1918, as the successor of a partnership formed in about 1884.

The petitioner's returns for the years 1918 and 1919, showing a tax liability of $8,140.32 and $8,755.95, were filed on June 5, 1919, and March 12, 1920, respectively. Some time in 1921, the petitioner's accounts were audited by a revenue agent, who proposed, as a result of the audit, that an assessment be made for additional taxes.

On December 28, 1921, the petitioner filed amended returns for the years 1918, 1919, and 1920, together with a brief concerning its tax liability for those years. The amended returns indicated additional tax liability of $21,960.11 for the year 1918, and $9,582.01 for the year 1919.

Under date of October 14, 1925, the respondent notified the petitioner by letter that there had been assessed against it for the years 1918 and 1919, additional income and excess-profits taxes of $31,542.12, this sum being equal to the total of the additional taxes shown by the amended returns filed by the petitioner for those years. In the statement accompanying the letter the respondent said, in connection with his assessment for the year 1918, that:

Since the statute of limitations has expired with respect to all additional taxes for the year under consideration except that shown on your amended return filed December 28, 1921, the additional assessment has been made in the latter amount.

and as to the year 1919, that:

The latter amount has been assessed, being the amount shown on your amended return which is accepted as waiving the statutory limitation to that extent.

The additional tax found to be due was assessed under the provisions of section 274(d) of the Revenue Act of 1924, on lines 3 and 4 of page 1 of the respondent's November, 1925, list.

On November 20, 1925, the collector of internal revenue at Brooklyn sent the petitioner a notice and demand for the additional taxes assessed and on or about November 27, 1925, the petitioner filed with the collector a claim for abatement of all of the additional assessments. The collector declined to receive the claim without ample security for the payment of such taxes as might be found to be due after a consideration of the claim. Security, consisting of various bonds of the face amount of $42,000, was deposited by the petitioner with the Corn Exchange Bank under an escrow agreement dated November 27, 1925.

On December 11, 1925, the respondent issued a 30-day letter advising the petitioner of a "remaining deficiency" in tax for the year 1919 of $6,774.23. In the statement attached to the letter the respondent said the following:

The following statement was made in the above mentioned office letter in connection with the assessment of $9,582.01: "The latter amount has been assessed, being the amount shown on your amended return which is accepted as waiving the statutory limitation to that extent". This action was taken in view of the fact that appearently there was no waiver on file for the year in question. Since that date, however, a waiver extending the statutory period of limitation for the year 1919 and bearing the signature of your vice-president James Doig, has been brought to light. This waiver which had become separated from the file of the case was received in the Income Tax Unit on November 24, 1924. You may, therefore, disregard the statement made in office letter dated October 14, 1925, as quoted above, in so far as the right of the Unit to make an assessment is concerned for the year in question.

The petitioner protested the deficiency proposed in the letter.

The petitioner's claim for abatement was rejected by a 60-day letter dated March 27, 1926.

Under date of June 7, 1924 the respondent requested the petitioner in writing to execute a form of "waiver," enclosed with his letter, extending the statutory period of limitations for the assessment of additional taxes for the year 1918, one year. The petitioner executed the form of "waiver" transmitted with the letter and on June 9, 1924, forwarded it to its counsel in this proceeding with instructions to "forward the same, if, in your opinion, it is correct." Petitioner's counsel gave the executed instrument to his stenographer with instructions to mail it to the respondent.

During November, 1924, counsel for the petitioner conferred with the respondent in Washington regarding its tax liability. Subsequently in the same month, the counsel recommended to the petitioner that it execute certain "waiver" forms obtained from the respondent during the conference extending for a period of one year the statutory period of limitations for the assessment of taxes for the years 1918 and 1919. The petitioner declined to execute the form of "waiver" provided by the respondent, and on or about November 22, 1924, signed and transmitted by letter to the respondent consent agreements for the years 1918 and 1919, reading, with the single exception of the year involved, as follows:

William S. Doig, Inc. a corporation, organized under the Laws of the State of New York, hereby waives the statutory limitations with respect to the period provided for auditing their Income Tax return by the United States Government and the rendering of any additional assessments found thereon for the taxable year 1918 and agree that such audits and assessments may be rendered subsequent to the limitations of time for such audits and assessments prescribed by the statute.

The consent agreements were signed by James Doig as vice president of the petitioner, and sometime after the delivery of the consents the respondent's name was affixed thereto. Each instrument bears a notation that it was received in the office of the respondent on November 24, 1924.

During the year 1919 the petitioner employed two men to do drawing work and a like number of men for pattern work. One of the draftsmen was known as a designer, who, with the assistance of the petitioner's superintendent and vice president, considered requests of customers for and made sketches of new machines. In the event they concluded that the idea presented to them for consideration was meritorious, the sketch made of the proposed machine was handed to the other draftsman for the necessary detail work. From 50 to 75 per cent of their time was spent preparing drawings for new patterns and the balance on general maintenance work. The pattern makers kept patterns in repair; rebuilt patterns damaged beyond repair, and made new patterns. About 75 per cent of their time was spent in repairing old patterns and the remainder on new patterns. The petitioner took an inventory of its drawings and patterns on hand at the end of the year 1919. Some patterns may be used as long as 10 years. Changes were made in the drawings from time to time which rendered the original drawing obsolete.

During the year 1919 the petitioner capitalized $1,052.57 of the cost of drawings and charged the balance of $979.69 to business expense. The amount capitalized represents the cost of new drawings for new designs of machines and the amount charged to expense represents the cost of maintaining old drawings, and the drawing expense of experimental work. None of the cost of patterns, amounting in 1919 to $2,974.08, was capitalized. All of it was charged to expense. This method of treating the cost of drawings and patterns on the corporate books has been in effect since April 1, 1918, and was used by the petitioner's predecessor for 20 years.

On an audit of the petitioner's returns for 1919, the respondent capitalized the expense items of $979.69 charged to drawings and $2,974.08 charged to patterns and computed depreciation on the balance in the account on the first day of the year at the rate of 10 per cent per annum.

In connection with its business the petitioner used small tools known as drills, taps, reamers, drilling machine cutters, counter bores, tool bits, gear cutters, electric drills, slotting machines, and slip saws. Many of these tools break easily while in use and have to be ground often to keep them in working condition. The cost of small tools purchased in 1919 and the maintenance cost of tools on hand were charged to expense in 1919. Of the total of $5,755.45 charged to expense in 1919, $4,110.72 represented the cost of the tools purchased and $1,644.73 the cost of maintaining tools on hand in working condition. The life of these small tools ranges from a day to four or five years. The year 1919 was a large business year for the petitioner.

On an audit of the petitioner's returns, the respondent capitalized $351.06 of the original and maintenance cost of small tools charged to expense in 1919, and of the amount charged to expense in 1920, capitalized $362.02 and allowed the balance of $4,161.45 as a business expense. The respondent computed depreciation each year at the rate of 10 per cent per annum on the balance in the account on the first day of the year.

The furnace of the case hardening plant of the petitioner was constructed of fire brick, which burn out every two years and have to be replaced. The frame within which the furnace is located had a much longer life. On an audit of petitioner's return for 1920, the respondent reduced the petitioner's claim of depreciation on the plant from 10 to 5 per cent per annum.

The parties have stipulated that the iron building should be depreciated for the year 1920 at the rate of 25 per cent per annum on a cost of $4,835.62. In determining the petitioner's tax liability for the year 1920, depreciation should be allowed on the property in the amount of $1,208.91.

In determining the petitioner's tax liability for the years 1919 and 1920, the respondent reduced the former's invested capital for 1919 by $12,720.44, this sum being the prorated amount of taxes determined by respondent for 1918, and for the year 1920 by $30,859.69, the total of taxes determined by respondent for 1918 and the prorated amount of taxes determined by him for the year 1918.

OPINION.

ARUNDELL: Of the arguments advanced by the petitioner against the validity of the consent agreements it executed on or about November 22, 1924, for the years 1918 and 1919, the material contentions are that the documents (1) do not bear the personal signature of the Commissioner, (2) lack a definite expiration date, (3) were executed subsequent to the expiration of the statutory periods of limitation, and (4) do not bear the corporate seal of the petitioner as required by the form adopted by the respondent. The facts involved in the questions raised by the petitioner do not differ in any material respect from those in proceedings heretofore passed upon by us contrary to the contentions being made. ; ; ; ; ; and .

The return for 1918 was filed on June 5, 1919, and the return for 1919 was filed on March 12, 1920. The statutory periods of limitation for the respective taxable years expired on June 5, 1924, and March 12, 1925. Section 277(a)(2), Revenue Act of 1924. The consent agreements filed by the petitioner for an extension of the statutory period of limitations for the assessment of taxes do not contain a definite expiration date, hence they operate to extend the statutory period a reasonable time after their date of execution. The respondent's final determination of the petitioner's tax liability for the years covered by the agreements was made on March 27, 1926, approximately two years after the expiration of the statutory period of limitations for the year 1918 and one year after such period had expired for the year 1919. The petitioner is not contending, and we find no evidence of record to warrant a holding, that the respondent failed to determine the deficiency in controversy within a reasonable time after the execution of the consent agreements. It is our opinion that the assessment of the deficiencies for the years 1918 and 1919 is not barred by the statute of limitations.

The petitioner also contends that the jeopardy assessments made by the respondent for the years 1918 and 1919 were illegal because no jeopardy existed at the time they were made. In , cited with approval in , and , we held that the Board will not inquire into the basis for the Commissioner's belief that jeopardy exists.

In the computation of the deficiency for 1919, the respondent adjusted the petitioner's account for patterns, woodcuts, drawings and photos, by capitalizing the amounts of $979.69 and $2,974.08, a total of $3,953.77, charged to expense for drawings and patterns, and allowed depreciation on the balance in the account at January 1, 1919, at the rate of 10 per cent per annum. The petitioner does not question the rate of depreciation allowed by respondent but contends that these two amounts are properly chargeable to expense and should not be capitalized.

We are satisfied from the evidence that the allocation made by petitioner in its books of the amounts expended for drawings is correct, and that $1,052.57 should be capitalized and $979.69 should be charged to expense. The testimony with reference to the patterns was to the effect that 75 per cent represented repairs and 25 per cent represented expenditures for new patterns. We are of the opinion that 25 per cent of $2,974.68 should be capitalized and the balance should be allowed as an expense and as such deductible from income.

The statement attached to the deficiency letter shows that the respondent exhausted small tools at the rate of 10 per cent per annum from 1901 to 1917, and during 1917 and 1918 at the rate of 20 per cent, due to increased production during those years. During the years 1919 and 1920 depreciation was allowed at the annual rate of 10 per cent on the balance in the account on the first day of the year. The petitioner claims that the rate should be 30 per cent.

The petitioner's vice president testified that the life of small tools in use is from one minute to four or five years and an average of two and one-half years. The petitioner's factory superintendent testified that the tools had an average life of three years. This evidence was in no way refuted by respondent and we are satisfied represents the true life of these tools. Petitioner asks for a depreciation of 30 per cent and this should be allowed for the years 1919 and 1920.

As to the question concerning the proper rate of depreciation for the petitioner's case hardening plant, the superintendent of petitioner's plant testified that the fire bricks comprising the furnace of the plant burn out and the furnace has to be replaced every two years. He also testified that the frame within which the furnace is located "would probably last a lifetime." This testimony constitutes all the evidence before us on the probable life of the plant and is insufficient upon which to base a rate of depreciation other than that used by the respondent. Accordingly, the respondent's determination is sustained.

The adjustment of petitioner's invested capital for the years 1919 and 1920 on account of taxes due for prior years was correct in principle, but the amount thereof should be recomputed in the light of the foregoing opinion. Section 1207, Revenue Act of 1926 and .

Judgment will be entered under Rule 50.