Royal Tailors v. Commissioner , 18 B.T.A. 731 ( 1930 )

THE ROYAL TAILORS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Royal Tailors v. Commissioner

Docket No. 21998.

United States Board of Tax Appeals

18 B.T.A. 731; 1930 BTA LEXIS 2599;

January 10, 1930, Promulgated

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Cost of certain books of samples used by petitioner should not be included in the computation of invested capital for the year 1920 on the basis of a two-year useful life of such books.

Joseph R. Little, Esq., and C. D. Hamel, Esq., for the petitioner.

Brooks Fullerton, Esq., for the respondent.

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LANSDON

The respondent has asserted a deficiency in income and profits taxes for the year 1920, in the amount of $44,757.35. At the hearing the petitioner abandoned all but one of its pleaded allegations of error. The only issue remaining is whether the cost in the taxable year of sample books used by the petitioner in the sale of its merchandise should be regarded as an ordinary and necessary business expense or as a capital expenditure.

FINDINGS OF FACT.

The petitioner is a Maine corporation, with its principal office in Chicago, Ill., where it is engaged in the business of "tailoring for the trade."

In the conduct of its business the petitioner uses books of samples which are made up and distributed twice yearly at or about the first of January and July, with samples of woolen goods suitable for wear in spring or summer and fall or winter, respectively. Each book contains small pieces of "swatches" of cloth which embrace all lines of materials carried by petitioner, and when orders are taken the customer's choice of material and style must be made from a sample book. The books are distributed throughout the United States and in a few foreign countries, to haberdashers, cleaners, clothing stores and other concerns willing to act as agents for the petitioner. Sales are made only through such agents and selections are always made from the sample books. After measurements are made by an agent, the order is sent to the petitioner's factory, where the suit of clothing is tailored to the individual measure of the customer and is usually completed and shipped within seven days of the receipt of the order.

The costs of the sample books purchased by the petitioner for the years 1917 to 1921, inclusive, were as follows: 1917, $263,821.18; 1918, $95,307.05; 1919, $181,939.51; 1920, $225,624.82; 1921, $122,246.96. In each of such years the entire cost of sample books was charged to expense.

Each sample book covers a certain amount of "yardage" of woolens offered for sale in the season of its issue. Ordinarily about 80 per cent of the goods sampled in any given books is sold in the year in which it is distributed. The unsold 20 per cent is carried over to the next year and not more than 50 per cent thereof in any line is sold in the second year, from the old sample book, and the remainder is re-sampled and included in the then current sample book.

The petitioner made a timely return of its income for 1920 and therein deducted the cost of sample books used in such year as an item of operating expense. Upon audit the deduction so taken was approved by the Commissioner, certain adjustments of invested capital, principally relating to the value of good will paid in for stock in 1914, were made and the deficiency here in controversy was asserted.

OPINION.

LANSDON: The petitioner contends that the cost of its sample books distributed in 1920 should be included in its invested capital and amortized over a period of two years. The evidence as to what extent the useful life of such books extends into the year succeeding their distribution is not clear. The witnesses called by petitioner agree that at least 80 per cent of the yardage sampled in 1920 was sold in that year and that at least 50 per cent of that unsold was re-sampled and included in books issued in the next year. It would seem, therefore, that at the most only 10 per cent of the yardage sampled in 1920 was sold from the same books in 1921. In these circumstances we think true income for the taxable year can be more accurately determined by the method of carrying prepaid charges into assets for 1921 than by any possible adjustments based on the theory that expenditures in question should be capitalized.

The petitioner is under the further disadvantage of failing to prove the dates within the year at which the alleged capital expenditures were incurred and, even if its basic contention is sound, it would be impossible to determine the correct time element for the computation of depreciation and the proration of the cost into invested capital unless the entire amount thereof should be so included for the entire year which, on the face of the record, would be entirely erroneous.

For many years prior to and succeeding the taxable year the petitioner charged the cost of sample books to expense and deducted the amounts thereof from its gross income in computing its liability for Federal income taxes. It now proposes, for the profits-tax years only, that it be allowed to include such costs in the computation of its invested capital, presumably for the purpose of increasing its profits-tax credits. An honest readjustment on the basis sought would necessarily involve the restoration of sample book cost to income in each of the years involved, with a consequent increase in tax liability that might or might not be offset by additional profits-tax credits. The petitioner certainly does not believe that it can be permitted to capitalize the cost of its sample books and at the same time deduct the amount thereof from its gross income as operating expenses, but unless this could be done it is probable that its victory here might be quite expensive.

Decision will be entered under Rule 50.