F. U. Stearns & Co. v. Commissioner ( 1928 )

F. U. STEARNS & CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

F. U. Stearns & Co. v. Commissioner

Docket No. 13135.

United States Board of Tax Appeals

14 B.T.A. 689; 1928 BTA LEXIS 2940;

December 12, 1928, Promulgated

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">*2940 1. Evidence found insufficient to establish that a contract assigned to petitioner upon its organization in exchange for its capital stock had any actual cash value.

2. No abnormalities of capital or income existing, assessment under section 328, Revenue Act of 1918, denied.

Herbert C. Smyth, Jr., Esq., for the petitioner.

Maxwell E. McDowell, Esq., for the respondent.

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PHILLIPS

">*689 The Commissioner determined a deficiency of $12,760.32 in income and profits taxes for 1920. The petitioner instituted this proceeding for a redetermination of its liability. It is alleged in the petition that the respondent committed error in excluding from invested capital the amount claimed by petitioner as the value of a contract assigned to it by Frank U. Stearns, on January 1, 1911. Petitioner seeks relief in the alternative under sections 327 and 328 of the Revenue Act of 1918.

FINDINGS OF FACT.

Petitioner is a New York corporation and is engaged in business as a selling agent. It was incorporated December 28, 1910, and organized January 1, 1911. At the time of organization it had an authorized capital stock, common, of $200,000 par value. ">*2941 On or about January 1, 1911, $500 par value of this stock was issued for cash, and $199,500 par value in exchange for a contract. There was issued in 1911 preferred stock in the amount of $55,000 par value, and in 1915 there was issued preferred stock in the amount of $20,100 par value, and of which was paid for in cash. The $71,100 par value of preferred stock outstanding and issued for cash was included in the invested capital by the respondent.

In 1902 Frank U. Stearns, who was at that time manager of the cotton goods department of A. D. Julliard & Co., became the exclusive selling agent for the Renfrew Manufacturing Co., a Massachusetts corporation, engaged in the manufacture of ginghams, damasks and novelty wash goods. Stearns thereafter acted as selling agent for the Renfrew Manufacturing Co. Stearns was associated with other corporations engaged in business as dry goods commission merchants or factors; first, with Julliard & Co., then, with Treat & Converse; and finally with Converse & Co., who succeeded Treat & Converse. Under this selling arrangement the factors maintained the sales organization, advanced money to the Renfrew Manufacturing ">*690 Co. on merchandise">*2942 manufactured, and collected the bills for goods sold. For this service they received a commission on goods sold. Stearns received his remuneration from the factor.

In 1908 Stearns was made treasurer of the Renfrew Manufacturing Co., and moved from New York to Adams, Mass. Thereafter he gave practically all of his time to the mill. He retained the sales contract with the Renfrew Manufacturing Co. The sales organization remained with Treat & Converse, who continued to act as factors for the Renfrew Manufacturing Co.

Sales conditions with Treat & Converse were not satisfactory to Stearns and on December 16, 1910, he entered into a contract with the Renfrew Manufacturing Co., which provided as follows:

MEMORANDUM OF AGREEMENT made and entered into this sixteenth day of December, Nineteen Hundred and Ten, by and between RENFREW MANUFACTURING COMPANY, a Massachusetts corporation, of the first part and FRANCIS U. STEARNS, of the Town of Adams, Massachusetts, of the second part, WITNESSETH:

That for and in consideration of the sum of One Dollar, lawful money of the United States, and other good and valuable consideration, by each of the parties to the other paid, receipt of">*2943 which is hereby respectively acknowledged, and in consideration of the covenants and agreements hereinafter contained, it is mutually understood and agreed as follows:

FIRST: That the first party shall and will sell through the second party all woven fabrics made and manufactured by it, and shall pay to the second party the commissioner of three and three-eighths (3 3/8%) per cent. on all net sales of such woven fabrics; and in addition thereto shall also pay the following charges, viz., storage and labor on goods stored elsewhere than in the store and warehouse of the second party; all freight and cartage for delivery of merchandise sent to the store or warehouse of the second party; all freight and cartage for returns or delivery of said merchandise elsewhere by the order of the second party on such merchandise; all moneys advanced or expended by the second party for insurance on merchandise stores outside of the second party's store or warehouse; all telephone and telegraph toll to the mills of the first party incurred by the second party, or by those employed by him, in the conduct of the business; all express on merchandise and samples; all freight where freight is allowed to">*2944 purchasers; cartage, all discounts, allowances and interest allowed to purchasers; all travelling expenses to and from the mill of the first party, incurred by the second party or his employees.

SECOND: That the first party in case of fire in its mills, shall pay a proportionate share of the salaries and wages of any or all employees of the second party, except the salary of F. U. Stearns, and for such period or periods as any or all of said employees shall be idle because of such fire, and no longer. The proportion to be paid by the first party shall be equivalent to the proportion that the sales of the merchandise of the first party bear to the total sales of merchandise made by the second party on all business conducted by him, and no more.

THIRD: That all merchandise of the first party sold by the second party shall be billed in the name of L. F. Dommerich & Co. of 57 Greene Street, New York City, in accordance with the agreement heretofore executed between the Renfrew Manufacturing Company and the said L. F. Dommerich & Co., under date of November 25th, 1910.

">*691 FOURTH: That the second party shall and will maintain an adequate organization for the sale and distribution">*2945 of the merchandise of the first party, and shall and will devote the time and attention necessary to the proper sale and disposition of the merchandise manufactured by the first party and sold through the second party; and shall manage the sale and disposition of such merchandise to the best of his ability for the commission of three and three-eighths (3 3/8%) per cent, on all net sales, which commission shall be paid to the second party on the third day of each month for the previous month's sales.

FIFTH: This agreement shall continue in force from the 1st day of January, 1911, to the 31st day of December, 1912, and is to be renewed from year to year on the same terms and conditions unless notice be given in writing by either party to the other of an intention to cancel and annul the same, at least six months before the expiration of any calendar year, beginning with the year 1912; and it is understood and agreed that the time of such termination commissions shall be charged by the second party and paid by the first party on all merchandise which may at that time have been sold and billed, but not on merchandise which may at that time have been sold but not billed, the intention">*2946 being that commissions shall be charged and paid under the terms of this agreement only on goods actually billed.

SIXTH: This agreement shall be assigned by the second party to F. U. Stearns & Company, a New York corporation about to be organized, as soon as organization is effected, and said corporation shall succeed to all the rights of the second party hereunder and said assignment shall release the said F. U. Stearns from any further liability hereunder; but no further assignment or transfer of this agreement shall be valid without the consent of the first party hereto.

IN WITNESS WHEREOF the first party has caused these presents to be executed by its duly authorized officers, and its corporate seal hereto affixed, and the second party has hereunto set his hand and seal, both in the City of Boston, Commonwealth of Massachusetts, on the day and year above written.

(Signed) RENFREW MANUFACTURING CO.

By % william h. hill, p/res't.

By WILLIAM H. HILL, Pres't.

(RENFREW SEAL)

This contract was assigned by Stearns to petitioner upon its organization January 1, 1911, for $199,500 par value of its capital stock. The contract was not canceled at the end of the">*2947 two-year term, and remained in force during the taxable year.

At the time of its organization all the stockholders of petitioner were stockholders in the Renfrew Manufacturing Co. William H. Hill, president of the Renfrew Manufacturing Co., was president of petitioner. Stearns, who was treasurer of the Renfrew Manufacturing Co. was also treasurer of petitioner. William F. Erwin, the assistant treasurer and nominal sales manager of petitioner was a director in the Renfrew Co., and a stockholder in both companies; and C. R. Smythe was a director and stockholder in both companies.

The sales manager for petitioner, after its organization, frequently consulted with Stearns over the telephone concerning the management of petitioner's business. Petitioner did only a sales business. ">*692 It did not act as factor for the Renefrew Manufacturing Co. L. F. Dommerich & Co. of New York financed that business. The cash which petitioner received from the sale of its preferred stock was necessary to finance its sales organization, and it was not financially able to do a factor business.

In addition to its income from commissions on Renfrew goods sold under its contract petitioner">*2948 had a small amount of income from other sources. The following table shows its income, dividends and surplus for the years indicated. Dividends were paid only on preferred stock:

	Commissions		Interest
			and	Gross		Net
	Renfrew	Other	dividends-	income	Expenses	income	Dividends
Year	goods	goods	income
1911	$53,012.97	$51.00	$2,390.06	$55,454.03	$47,664.19	$7,789.84	$3,869.99
1912	47,228.61	558.29	1,732.81	49,519.71	55,723.12	(6,203.41)
1913	51,805.84		2,491.60	54,297.44	45,782.50	8,514.94
1914	48,819.93		2,715.97	51,535.90	45,227.62	6,008.28	9,623.00
1915	56,233.64	5,161.01	2,285.12	63,679.77	55,340.49	8,339.28	3,850.00

Year	Surplus
1911	$3,919.85
1912	(2,283.56)
1913	6,341.38
1914	2,614.66
1915	7,103.94

During the five years preceding the organization of petitioner the exclusive selling agents for the Renfrew goods received a commission on sales of 4 1/2 per cent. The gross commissions on goods sold by these agents under their contract were as follows:

1906	$61,332.15
1907	73,268.88
1908	50,117.36
1909	70,404.39
1910	70,105.14

">*2949 Petitioner carried on its books and included in its invested capital for the taxable year 1920, $199,500 as the value of the contract assigned to it by Stearns for $199,500 par value of its capital stock. The respondent eliminated this amount from its invested capital in computing its tax liability for 1920.

OPINION.

PHILLIPS: The contract here in question was for the exclusive sale of all woven fabrics manufactured by the Renfrew Manufacturing Co. Prior to the organization of petitioner the contract for the exclusive sale of such merchandise had been held by Frank U. Stearns, who was associated with Converse & Co., dry goods commission merchants or factors of New York. In 1910 Stearns became dissatisfied with his arrangement with Converse & Co., and on December 16, 1910, entered into a new contract with the Renfrew Manufacturing Co. for the exclusive sale of their merchandise, which contract he ">*693 assigned to petitioner upon its organization January 1, 1911, for its common stock in the amount of $199,500 par value.

Petitioner claims the value of the contract assigned to it was in excess of $199,500 and asks that it be included in its invested capital at its">*2950 cash value. It introduced evidence of the gross commissions received by Converse & Co. from the exclusive sale of similar merchandise during the five years preceding its organization. There is no evidence as to the net commissions earned by Converse & Co. under their contract and we are unable to determine what such net commissions were. It is urged that they were comparative to the net earnings of petitioner during the years immediately following its organization. This does not necessarily follow from the fact that they were both exclusive contracts for the sale of similar goods. The conditions were different. They were executed at different times, by different parties under different selling and market conditions, and did not require the same services. Converse & Co. acted as factors as well as selling agents and received a commission of 4 1/2 per cent, while petitioner acted only as selling agent and received a commission of 3 3/8 per cent. The record fails to show any basis on which the gross commissions earned by Converse & Co. may be used to measure the value of the contract acquired by petitioner, nor do the earnings of the petitioner during the five years immediately">*2951 following its organization indicate that the contract had a market value. After eliminating its income from other sources, petitioner's net income from the contract in question from 1911 to 1915, inclusive, was $7,063.07; an average of $1,412.61 per year. This was at most no more than a fair return on the capital stock which petitioner had issued for cash. We are unable, on the basis of this evidence, to give any cash value to the contract here in question for invested capital purposes.

It will be noted that the contract provided that it would continue in force for two years and thereafter would be renewed from year to year, but cancelable at the option of either party by notice given six months before the expiration of any calendar year. Such a provision would militate against the assignment of any substantial cash value to the contract for invested capital purposes.

There is some opinion evidence as to value, but such testimony is clearly based upon a knowledge of the earnings of petitioner several years later and is not acceptable as evidence of the value of the contract on June 1, 1911.

The respondent has included in invested capital the par value of the stock issued">*2952 for cash. The record does not bring to our attention any abnormal conditions affecting the capital or income of ">*694 petitioner. We conclude that petitioner is not entitled to have its tax computed under section 328 of the Revenue Act of 1918 by reason of any abnormal conditions affecting its income or capital.

Decision will be entered for the respondent.