Ruud Mfg. Co. v. Commissioner , 15 B.T.A. 819 ( 1929 )

RUUD MANUFACTURING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Ruud Mfg. Co. v. Commissioner

Docket No. 16278.

United States Board of Tax Appeals

15 B.T.A. 819; 1929 BTA LEXIS 2789;

March 12, 1929, Promulgated

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">*2789 1. Respondent's refusal to include in invested capital any amount for good will acquired for stock sustained in the absence of proof of the value of any good will acquired.

2. Depreciation rate for manufacturing equipment determined.

3. Respondent's action in disallowing as a credit in 1921, taxes paid to the canadian Government in that year for the years 1918 and 1919, sustained.

Maynard Teall, Esq., for the petitioner.

Earl W. Shinn, Esq., and Edwin M. Niess, Esq., for the respondent.

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ARUNDELL

">*819 This proceeding is for the redetermination of deficiencies of $8,717.15 and $7,312.63 in income and excess-profits taxes of the years 1920 and 1921, respectively. The errors alleged are: (1) The reduction of invested capital each year by the sum of $103,159.33, representing good will acquired for stock, (2) the reduction of depreciation by $27,320.26 and $19,999.95 for the years 1920 and 1921, respectively, (3) the disallowance as deductions of certain donations made in 1920 and 1921 in the respective amounts of $524.20 and $566.55, and (4) the disallowance as a credit against 1921 taxes, of the sum of $4,917.92 paid to the Canadian">*2790 Government in that year for income tax.

FINDINGS OF FACT.

The petitioner, a New Jersey corporation, with principal office at Pittsburgh, Pa., is and was during the taxable years, engaged in the manufacture and sale of gas water heaters.

Prior to the year 1913, the Humphrey Company, a Michigan corporation, was engaged in a like business at Kalamazoo, Mich. Excepting qualifying shares, all of its stock was owned by H. F. Humphrey.

">*820 On March 24, 1913, the petitioner and the Humphrey Co. entered into a written agreement for the purchase by the former of the latter's assets, including good will, and patents, issued and pending. The pertinent clauses of the contract read as follows:

In consideration of the said sale and transfer the said party of the first part agrees to issue to the said Humphrey Company or to the stockholders thereof in such proportions as may be determined by them, two hundred and ninety (290) shares of the par value of One Hundred ( $100) Dollars each of the full-paid capital stock of the said party of the first part, and said party of the first part warrants that the total issue of its stock now outstanding is thirteen hundred and twenty-two">*2791 (1322) shares.

It is covenanted and agreed between the parties hereto that as soon as convenient, and not later than the first day of April, 1913, an appraisement shall be made by the American Appraisal Company of the real estate and buildings thereon owned by the respective companies and of the equipment of the respective factories, stock of manufactured goods, goods in process of manufacture and materials on hand therein belonging to the respective companies. All other property of the respective companies excluding good will and patents shall be appraised by A. P. Brill and F. A. Lemke, whose decision shall be final as to such valuation. The accounts and bills receivable of the respective companies shall be taken at their book value. Upon the value of the respective assets of the companies, excluding as aforesaid good will and patents, being ascertained in the manner hereinbefore stated, the net assets shall be ascertained by deducting from the respective amounts belonging to the different companies the net amount of debts owing by each company, and such net assets as thus ascertained shall be the basis for distribution of preferred stock hereinafter provided to be issued.

">*2792 The said party of the first part covenants and agrees to purchase the property and assets of the said party of the second part upon the basis aforesaid and to issue the said 290 shares of stock upon receiving the conveyance, assignment of patents and bill or bills of sale aforesaid. And it further agrees that as soon as convenient and not later than six months from the date hereof it will increase its capital stock by authorizing an issue of one million preferred non-voting cumulative seven percent stock which shall take precedence of its existing issue of stock which preferred stock shall be preferred not only as to dividends but also as to distribution of the assets of the corporation and further that it will authorize the distribution of the said preferred stock in the nature of a stock dividend out of surplus.

In making such distribution of the said preferred stock the appraisement aforesaid of the net assets of the respective companies shall be the basis for distribution of said preferred stock between the respective companies and there shall be given to the present stockholders of the Ruud Manufacturing Company holding the issue aforesaid of 1322 shares, an amount of the">*2793 said preferred stock at par corresponding with the amount of its net assets, and in similar manner there shall be issued to the said Humphrey Company an amount of said preferred stock at par corresponding with its net assets. When the respective shares of the two companies has been ascertained, there shall be deducted from the shares of the said Humphrey Company, twenty-five thousand ($25,000.00) dollars par value of the said preferred stock which shall be added to the shares of the Ruud Manufacturing Company to be distributed among the holders of the said 1322 shares.

">*821 On June 12, 1913, the following statement of the net assets of the respective companies, prepared pursuant to the agreement of March 24, 1913, was accepted by the petitioner's board of directors:

	Ruud	Humphrey
Cash	$9,681.88	$2,768.71
Accounts and bills receivable	198,186.49	86,506.67
Real estate	125,856.00	81,408.23
Inventory	240,175.19	80,835.46
Consigned stock	80,202.30	39,192.51
Factory equipment	56,253.25	48,772.44
Branch office equipment	7,500.00	6,000.00
Branch office parts	3,821.27	828.67
Patterns	8,219,02	6,029.54
Advertising and stationery	14,622.75	9,537.90
	744,518.15	361,880.13
Less liabilities	162,518.15	20,880.13
	582,000.00	341,000.00
Plus royalty for thermal valve heaters manufactured	25,000.00
Less amount paid Ruud in royalties		25,000.00
	607,000.00	316,000.00

">*2794 At the same meeting, the directors instructed the proper officers of petitioner to issue 290 shares of its stock to the Humphrey Co. or its nominee as provided by the agreement of March 24, 1913.

At a special meeting of petitioner's stockholders, held on July 14, 1913, its authorized capital was increased to $1,500,000. The stockholders at an annual meeting held on the same date, passed the following preamble and resolution:

WHEREAS, by contract entered into between the Ruud Manufacturing Company and the Humphrey Company of Kalamazoo, Michigan, dated the 24th day of March, 1913, the Ruud Manufacturing Company purchased the whole property and business of the said Humphrey Company, and agreed to pay therefor 290 shares of the present stock of the Ruud Manufacturing Company, and $316,000.00 for 3160 shares of the issue of Preferred Stock, to be authorized by the stockholders of the Company.

WHEREAS, the Stockholders have this day authorized an issuance of $1,000,000.00 of Preferred Stock, and $500,000 Common Stock, which Preferred and Common Stock are to be the authorized Capital Stock of the Company, as shown by the amendment to the Certificate of Incorporation, about to be">*2795 filed, and,

WHEREAS, the assets and property of the Ruud Manufacturing Company aggregate the sum of $1,875,432.28, and the present amount of stock outstanding is 1612 shares or $161,200.00 Par Value, and there is therefore a surplus of $1,714,234.28, and

WHEREAS, it has been thought desirable that the said surplus be not distributed in cash to the Stockholders, but that same should be in part capitalized, so that the total capital of the company should be $1,000,000.00 Preferred Stock and $500,000.00 Common Stock, and as aforesaid the Stockholders have authorized an increase of capital to that amount; the surplus thereafter existing to remain undisturbed.

Now THEREFORE BE IT RESOLVED, that the Board of Directors be, and they are hereby authorized; first, out of the said Preferred Stock to issue to the Humphrey ">*822 Company or its nominees, $316,000.00 Par Value thereof, in accordance with the provisions of the agreement of March 24, 1913, and that the remaining Preferred Stock, $607,000.00 thereof, to be issued to the present Stockholders of the Ruud Manufacturing Company, excluding H. S. Humphrey and F. A. Lemke, ratably and proportionately as a stock dividend in proportion">*2796 to their holdings as Stockholders of the Ruud Manufacturing Company. Second, that the common Stock for the full amount thereof be issued to the present Stockholders of the Ruud Manufacturing Company as a stock dividend ratably and proportionately being an increase of $338,800.00.

After the completion of the sale, petitioner operated the plant purchased as the Humphrey division of its business.

After the completion of the sale, petitioner operated the plant $30,000. No additional money was invested in the business between 1898 and 1913.

The gross sales, net profits or loss, and advertising expenditures of the Humphrey Co. each year from 1904 to 1912, inclusive, and its net tangible assets at the close of the years between 1908 and 1912, inclusive, were:

	Gross sales	Net profit or loss	Advertising expenditures	Net tangible
1904	$81,797.73	$23,119.11	$8,749.09
1905	125,166.53	21,816.32	26,610.40
1906	120,031.80	17,140.05	21,466.71
1907	128,904.99	23,923.75
1908	102,065.65	17,211.29	19,644.61	$30,648.19
1909	296,073.99	21,409.75	25,748.39	53,670.56
1910	339,317.66	19,926.75	44,851.05	96,717.01
1911	360,058.50	1 6,044.52	39,772.53	90,402.58
1912	495,350.16	1 4,384.09	41,669.19	83,611.58

">*2797

The gross sales, profits and net tangibles of the Humphrey Division of petitioner each year between 1914 and 1920, were:

	Gross sales	Profits	Net tangibles
1914	$512,303.06	$53,029.30	$406,351.51
1915	539,942.41	73,664.06	465,114.57
1916	768,581.07	79,753.73	513,346.30
1917	991,382.14	96,840.76	597,267.06
1918	664,071.77	17,326.46	582,491.51
1919	1,110,695.00	140,795.44	714,603.94
1920	1,546,025.89	90,538.65	851,097.96

The reduction in sales and profits in 1918 over previous years was the result of war conditions.

The annual drawing account of H. S. Humphrey for the year 1904 was $10,000; for the years 1905 to 1909, inclusive, $12,000; and for the years 1910 to 1912, inclusive, $36,000. After the reorganization, he received an annual salary of $6,000 from the petitioner. Humphrey ">*823 devoted all of his time to the business before and after the reorganization.

The parties have stipulated that the manufacturing equipment used by the petitioner in its business, classified as machine tools, small tools, patterns, transmission machinery, including motors, ovens and furnaces, and presses, had a value">*2798 in 1920 and 1921 for depreciation purposes of $123,582.39 and $153,590.13, respectively. A reasonable rate of depreciation for the equipment is 10 per cent per annum.

The parties have also stipulated that all of the donations disallowed by the respondent as deductions, should be allowed, with the exception of an item of $200, representing wedding gifts to employees in 1921, which item should be disallowed.

By notices dated July 13, 1921, and July 14, 1921, the Commissioner of Taxation, Dominion of Canada, notified the petitioner that it had been assessed a tax of $1,375.46 and $3,542.46 for the calendar years 1918 and 1919, respectively, under the provisions of the Business Profits War Tax Act, 1916, the tax assessed being equivalent to one-fourth of the profits realized on Canadian business, less certain credits, deductions and exemptions. The taxes assessed were paid by the petitioner July 20, 1921. With its return for the year 1921, the petitioner filed the form and claim required for the allowance of the taxes paid as a credit. During the taxable years, petitioner kept its books on the accrual basis.

OPINION.

ARUNDELL: The evidence before us on the question of the">*2799 value of any good will acquired for stock is confined to gross sales, profits and losses, advertising expenditures and net tangibles of the Humphrey Co. prior to the merger, and of the Humphrey Division of petitioner subsequent to that event. We are asked to determine from that evidence that the Humphrey Co. was possessed of a valuable good will which became the property of the petitioner by reason of the merger, and of the transfer of the business of the Humphrey Co. to petitioner, and to determine, from the same evidence, what the value of such good will may have been. We are asked to assume that all earnings of the Humphrey Co. in excess of a fair return upon its net investment in tangible properties are directly attributable to good will, and to capitalize such excess earnings at either 10, 15, or 20 per cent, and accept the result as reflecting the fair value of the good will. We decline, for obvious reasons, to take that course. We might just as well assume that all of the earnings in excess of a fair return on the tangibles were attributable directly to patents. The ">*824 Humphrey Co. was a manufacturing organization, and patents were specifically included in the">*2800 transfer of assets to the petitioner. The evidence does not justify one of these assumptions in preference to the other. Nothing has been given to us in the way of evidence as to the background of the successes and reverses of the Humphrey Co. We know nothing whatever as to its business policies, particularly as they affected the company's relations with its customers, as to the steps taken toward the development of markets for its products, and as to the reputation of its products as to grade, quality, and serviceability. Without this background, any conclusion that we might draw from the mere application of a formula to earnings would be entirely a matter of conjecture. ; .

While the case was tried on the theory that there was issued to the Humphrey Co. capital stock of the par value of $405,900, divided into $316,000 of preferred and $89,900 of common, we are not unmindful of the fact that the agreement of March 24, 1913, between the Humphrey and Ruud Companies provided for the sale of all of the former's assets to the latter for 290 shares of the latter's common">*2801 stock and the issuance thereafter of preferred stock of the Ruud Co. in an amount equal to the appraised value of the Humphrey Co.'s assets, specifically excluding therefrom the good will and patents. The issuance of preferred stock to the Humphrey Co. or its nominees in the par amount of $316,000 was pursuant to this agreement. The additional common stock was issued to the former stockholders of the Humphrey Co. as a stock dividend, pursuant to a stockholder's resolution adopted on July 14, 1913, and not under any provision of the agreement of sale.

The allegation of error respecting depreciation was abandoned at the hearing with the exception of exhaustion on manufacturing equipment, which the parties stipulated has a value for depreciation purposes of $125,582.39 and $153,590.13 for the respective taxable years. The petitioner is asking us to allow depreciation at the rate of 10 per cent claimed by it in its returns, instead of 7 per cent, the figure allowed by the respondent.

The uncontradicted testimony of the two qualified witnesses presented by the petitioner is that the manufacturing equipment has a useful life of 10 years. Their opinions are amply supported by their">*2802 testimony as to life of the various classes of equipment comprising the whole, and we are of opinion that 10 per cent is a fair rate and should be used in computing the reasonable allowance provided by the statute.

The contention of the petitioner respecting the remaining issue is, in substance, that the term "paid" as used in the taxing acts in connection ">*825 with credits allowed for taxes levied by foreign countries, means no more than "paid or payable," and inasmuch as the amount of taxes which it paid the Dominion of Canada for the years 1918 and 1919 was not known or payable until after the receipt in July, 1921, of notices of assessment, the taxes are a proper credit for the year 1921, the year in which they were paid, even though it kept its books on the accrual basis.

In support of its position, the petitioner has introduced into the record the Income War Tax Act, 1917, enacted by the Parliament of Canada, September 20, 1917, together with amendments thereto dated May 24, 1918, and July 7, 1919. The notices of assessment clearly show that the taxes paid were assessed under the provisions of the Business Profits War Tax Act, 1916, which act has not been proved, ">*2803 and is not therefore before us as a fact for a consideration of its terms. See . Without proof of the foreign law under the terms of which the taxes were levied and paid, we are unable to say whether they come within the class of income, war-profits and excess-profits taxes allowed as a credit by section 238 of the Revenue Acts of 1918 and 1921, and if we were to indulge in the presumption that the taxes are within that limited classification, we would still be unable to ascertain that they did not accrue or become payable prior to 1921, as determined by the respondent.

The petitioner also contends that as the amount of taxes paid to foreign countries is allowed as a credit against domestic income, war-profits and excess-rpofits taxes, as distinguished from a deduction from gross income, income would not be distorted in any way by taking the credit in the year in which the taxes are paid, even though that be after the taxes actually accrued. The word "paid" as defined by Congress in section 200 of the Revenue Acts of 1918 and 1921 applies to deductions and credits with equal force. That Congress intended taxpayers on an accrual basis">*2804 of accounting to take the credit when the taxes accrue, rather than when paid, is further evidenced by the terms of section 238 of the taxing acts, which provides for a refund or a credit or further payment of taxes in the event the accrued taxes when paid differ from the amounts claimed as credits.

In , we held that in general the phrase "paid or accrued" as used in the statute, is to be construed in the alternative and forbids the use of both bases in one income-tax return. See also .

Judgment will be entered under Rule 50.

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Footnotes

• 1. Loss. ↩