Rees Printing Co. v. Commissioner , 18 B.T.A. 931 ( 1930 )

REES PRINTING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Rees Printing Co. v. Commissioner

Docket Nos. 6705, 22642.

United States Board of Tax Appeals

18 B.T.A. 931; 1930 BTA LEXIS 2569;

January 27, 1930, Promulgated

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Evidence fails to show that respondent was unable to determine petitioner's invested capital. Special assessment denied.

Clinton Brome, Esq., and Amos Thomas, Esq., for the petitioner.

G. S. Herr, Esq., for the respondent.

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LANSDON

The respondent determined deficiencies in income and profits taxes for the fiscal years ended August 31, 1918 and 1919, in the respective amounts of $7,517.84 and $6,415.01. The deficiency for 1919 has been assessed and this proceeding is an appeal from a refusal to abate any part thereof. The only issue is whether for each of the years involved the petitioner was entitled to have its tax liabilities determined under the provisions of section 328 of the Revenue Act of 1918 because it was impossible for the Commissioner to determine the correct invested capital of the petitioner in either of the years under review. The two proceedings, involving identical issues, have been consolidated for hearing and decision.

FINDINGS OF FACT.

The petitioner is a Nebraska corporation, with its principal office at Omaha, where it is engaged in the general printing business. For each of the years here involved it made consolidated income and profits-tax returns for itself and the Rees Ticket Co., an auxiliary corporation with which it was affiliated on some basis not disclosed by the record, and such returns were accepted by the respondent and used in the determination of the deficiencies here in controversy. The Rees Ticket Co. is engaged in the manufacture of numbered tickets of admission, and the greater portion of its product is in the form of continuous strips of tickets made up in rolls and serially numbered.

About 1880 Samuel Rees, Sr., now deceased, engaged in the job-printing business in Omaha, and in 1884 he incorporated such business as the Rees Printing Co. In 1898 this company had a part of its property and all its books and records destroyed by fire.

Some time before the fire and for several years thereafter the petitioner conducted a separate department of its business for the manufacture of tickets used by theaters and other amusement enterprises and other similar numbered work such as coupon books. This separate department was incorporated September 1, 1913, as the Rees Ticket Co. The parties have agreed that in the taxable years the petitioner and the Rees Ticket Co. were affiliated and that the deficiencies here in controversy are based on consolidated income and profits-tax returns filed by the petitioner, as the parent corporation of the affiliated group.

In the fiscal year ended August 31, 1918, the statutory invested capital of the affiliated group, as determined by the respondent, was $131,365.75; and net taxable income of the petitioner was $30,677.64 and of the Rees Ticket Co., $5,644.12. It is impossible from the record here to segregate the invested capital of the two members of the group in 1918. Neither invested capital nor net earnings of either corporation for 1919 are disclosed by the record.

The petitioner kept the books of both corporations. Most of the records prior to and of the taxable years have been destroyed or lost and the books that have been preserved are incomplete and fragmentary. The books were not audited prior to 1918 and no systematic accounting system was adopted until 1923. A careful search for the missing books and records was made prior to the hearing and none was found.

From the time it began manufacturing tickets until about 1918 the petitioner used a flat-bed press, printing from type on sheets of paper. The tickets so produced were numbered serially by machines that were unsatisfactory. The volume of the ticket production increased during early years, but prior to 1913 it substantially declined for the reason that competitors, using better machinery, were able to produce in greater volume at lower costs. Prior to 1914 the types of machines required for rapid and satisfactory production of numbered tickets and coupon books were not available in commercial machinery markets.

In order to meet competition the petitioner, about 1912, began the development of an improved ticket-printing machine. Draftsmen and machinists were employed and a small machine shop apart from the petitioner's printing plant was acquired, equipped and maintained for the sole purpose of developing new machinery and conducting tests thereof and experiments incident to such purpose. The draftsmen and machinists so employed were paid substantial wages, aggregating several thousands of dollars, which were not capitalized but were handled through the petitioner's weekly pay rolls and charged to operating expenses. To an extent not disclosed by the record the cost of the materials used in development work was capitalized.

As a result of its development work, experiments and tests the petitioner, about 1914, was able to build a rotary type ticket-printing-and-numbering machine and increase production without any additional expense other than the added cost of paper used in the greater volume of business which it was enabled to secure. The capacity of the old flat-bed ticket press and its accessories was about 125,000 numbered tickets daily. The new upright rotary press, printing and numbering tickets continuously from rolls of paper, has a daily capacity of about 1,250,000 numbered tickets. The development and use of this machine enabled the petitioner to secure many large orders that could not have been filled under the old methods of production.

In its machine shop the petitioner also developed and manufactured new stereotyping machinery needed in its operations that resulted in substantial economies in the cost of labor and materials. The wages of the draftsmen and machinists employed for this purpose were substantial in amount and were charged to operating expenses of the petitioner through its weekly pay rolls. The materials used in the development and construction of this improved stereotyping machine were charged to capital in amounts not disclosed by the record.

In 1917 petitioner purchased sufficient additional type-casting machines and type metal to enable it to abandon the distribution of type from finished jobs in cases or racks from which it could afterwards be reset in building up forms for new orders, and thereafter dumped all used type into a melting pot to be fused into ingots to be used again and again in the operating of its type-casting machines. This change resulted in substantial operating economies through the use of labor and new equipment. The cost of the labor so used was charged to operating expense through weekly pay rolls, but the cost of new materials was capitalized.

OPINION.

LANSDON: The petitioner's single prayer is for relief under the provisions of sections 327 and 328 of the Revenue Act of 1918. The only pleaded basis for such relief is that its invested capital for the taxable year can not be determined. The evidence shows that the books and records of the petitioner are very fragmentary and that for its earlier years all have been lost. Notwithstanding the paucity of records, however, the respondent has determined the petitioner's invested capital for 1918 in the amount of $131,365.75, representing $100,000 capital stock and $31,365.75 surplus, and for the year 1919 in an amount not disclosed by the record.

The petitioner has proved that it spent considerable amounts in the development of an improved ticket-printing-and-numbering machine used by its auxiliary, the Rees Ticket Co., and that such machine enabled it to operate the ticket-printing drpartment of its business, incorporated separately for convenience, economically and efficiently and meet competition, secure business and earn profits not otherwise possible. One of the witnesses testified that about 60 per cent of the income of the affiliated group was earned by the Rees Ticket Co., and that such earnings resulted from the use of the new machine, the cost of which for the most part had been charged to expense. The record is not consistent with this testimony. The parties stipulated that the Commissioner has determined that the net taxable income of the petitioner in 1918 was $30,677.64, and that of the Rees Ticket Co. only $5,644.12. No evidence adduced by the petitioner challenges the accuracy of these figures. It is manifestly impossible, therefore, to accept as true the petitioner's allegation that 60 per cent of the consolidated income in such year consisted of profits earned by the ticket-printing department. There is no convincing proof that uncapitalized cost of ticket-printing machines or any other improvements made, as claimed by petitioner, contributed substantially to income in either of the taxable years.

As stated above, the respondent has determined invested capital for each year in controversy, and for one such year included therein capital stock and earned surplus in the respective amounts of $100,000 and $31,365.75. In the absence of proof of the nature or value of the assets represented by such capital stock and surplus, it is impossible for us to sustain the claim that invested capital can not be ascertained.

Decision will be entered for the respondent.