Central Waxed Paper Co. v. Commissioner , 15 B.T.A. 896 ( 1929 )

CENTRAL WAXED PAPER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Central Waxed Paper Co. v. Commissioner

Docket No. 8014.

United States Board of Tax Appeals

15 B.T.A. 896; 1929 BTA LEXIS 2775;

March 15, 1929, Promulgated

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SPECIAL ASSESSMENT - SECTION 327 OF THE REVENUE ACT OF 1918. - Influence exerted by officers and directors to the extent to which same increased business done held not sufficient to constitute an abnormality and bring the case within the purview of section 327.

Andrew T. Smith, Esq., for the petitioner.

James L. Backstrom, Esq., for the respondent.

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MILLIKEN

This proceeding results from the determination of a deficiency by the respondent for the year 1919 in the sum of $5,656.02. Two errors were alleged by the petitioner - (1) that the respondent erred in reducing petitioner's invested capital for the taxable year 1919 in the sum of $31,426.93, such reduction in invested capital being the result of the deduction by the respondent from invested capital of $74,365.66 income and profits taxes of the petitioner for the year 1918 paid in the calendar year 1919; and (2) the respondent erred in failing and refusing to compute the excess-profits tax of the petitioner for the year 1919 under the provisions of sections 327 and 328 of the Revenue Act of 1918.

The first assignment of error was abandoned by the petitioner at the hearing of this cause. Prior to the hearing of this cause, the Commissioner filed a motion to limit the hearing in the first instance in this cause to issues defined in subdivisions (a) and (b) of Rule 62 of the Board's rules of practice. Said motion was granted prior to the hearing of this cause.

FINDINGS OF FACT.

Petitioner was organized in April, 1915, by Andrew Christ, R. B. Donnelley, employees of Francis S. Peabody, and Francis S. Peabody, who, after the possibility of operating a corporation in the business of manufacturing waxed paper was presented to them by Christ and Donnelley, took the matter up with various friends and business associates of Peabody, and these associates, together with members of their families and employees and one or two friends of Christ and Donnelley, subscribed for the stock of petitioner.

During the year 1919 the taxable year in question, the authorized and outstanding stock of the petitioner consisted of 2,500 shares, all common of the par value of $100 per share, and was owned at December 31, 1919, by the following stockholders:

Stockholders	Shares owned
F. S. Peabody, vice president	2
R. J. Collins, treasurer	133
J. B. Jackson	110
D. P. Hurd	59
J. D. Adams, assistant secretary and treasurer	72
M. L. Harris, vice president	203
R. B. Donnelley, secretary and general manager	119
A. Christ, jr., president	251
Roger C. Sullivan, chairman, board of directors	234
C. F. Massey	5
W. A. Voltz	61
C. A. Brueggeman	18
C. P. Voltz	13
Mrs. W. A. Voltz	1
Daisy F. Christ	5
Paul Butler	55
E. L. Heffernan	233
Mary S. Peabody, vice president	412
Jessie S. Walker	52
R. C. Constantine, sales manager	114
Chas. Gilman	13
Freda Peter	26
Maud C. Donnelley	5
Walter Fisher	126
May Adams	117
Louis A. Solari	56
E. A. Gaffigan	5
Total shares	2,500

During the year 1919, dividends were paid on the 2,500 shares of common stock as follows:

January 12	$25,000
May 10	25,000

Francis S. Peabody was, in the year 1915, and throughout the year 1919, a prominent coal operator and owned coal mines in Illinois, Indiana, and Kentucky, as well as having a large distribution company in Chicago. He was also identified with various large industrial companies in Chicago and was well known through his wide business interests. He was chairman of the board of the Peabody Coal Co., a very large concern, chairman of the board of the Consumers' Co., the largest coal and ice distributor in the Middle West, and interested in many other companies. He devoted such time to petitioner's affairs during the year 1919 as was necessary for conference with the general manager of petitioner, and was paid a salary of $483.86. His wife, Mary S. Peabody, was paid a salary during the year 1919 of $624.99.

Francis S. Peabody was a director in several corporations in which William Wrigley of the William Wrigley, Jr. Co. was also a director. Early in the life of petitioner, probably in the year 1916, Peabody volunteered to speak to William Wrigley and see if he could increase the amount of sales being obtained by petitioner from the Wrigley Co. Thereafter, Peabody talked with Wrigley about the matter and suggested to the general manager of petitioner that he go and interview the Wrigley Co. This the general manager of petitioner did. The gross sales made to the Wrigley Co. in 1919 by petitioner amounted to $139,956.56. The 1918 sales to the Wrigley Co. amounted to $48,279.

F. S. Peabody also interviewed one of the directors of the Schultz Bread Co. in 1919, with a view to obtaining increased business from them for petitioner. During the year 1919 petitioner made gross sales to the Schultz Bread Co. in the sum of $34,469. In the year 1918 gross sales made to that company amounted to $58,148. The Schultz Bread Co. account was first solicited by the general manager of petitioner during the latter part of 1915. The interview which Peabody had with one of the directors of the Schultz Bread Co. was subsequent to the year 1915.

Roger C. Sullivan was prominent in industrial, financial and political circles in Chicago during the year 1919. He was connected with the People's Gas, Light & Coke Co. and the Commonwealth Edison Co. as a stockholder. He was practically the sole owner of the Sawyer Biscuit Co. He was identified with many other companies. He was prominent in Democratic politics in Illinois. He devoted such time to petitioner's affairs during the year 1919 as was necessary for conferences with the general manager of petitioner, and was paid a salary of $1,108.85. He urged the Sawyer Biscuit Co. to make its waxed paper purchases from petitioner and in the year 1919 petitioner made gross sales to that company of $5,471.65. Sullivan made other efforts in the year 1919 to get other business for petitioner, but his efforts were futile.

R. J. Collins was prominent in financial matters in Chicago. He was, in 1919 and theretofore, a director of the Union Trust Savings Bank and Mercantile Trust & Savings Bank, president of the Fulton Wholesale Market Co., and a large stockholder in the Knight Soda Fountain Co. He devoted approximately a full two months of his time during the year to the business affairs of petitioner and was paid a salary during the year 1919 of $2,500.

R. J. Collins had a cousin, M. J. Hogan, who was the western manager of the Biscuit & Crackers Manufacturers Purchasing Co., which is a company that makes combined purchases for independent cracker bakers. Collins introduced the general manager of petitioner to Hogan early in the existence of the company, probably in the year 1916. Thereafter, petitioner did business with the company which Hogan represented, which was to some extent the result of the introduction which Collins arranged to Hogan for the general manager of petitioner. In 1919 petitioner made gross sales to the Biscuit & Crackers Manufacturers Purchasing Co. in the sum of $59,457.94. In 1918 petitioner made gross sales to the same company of $114,722.16. The decline in business between 1918 and 1919 was attributable to a decrease in the cracker business in that year.

During the year 1919 it became necessary for the petitioner to borrow money. R. J. Collins was a director of the Mercantile Trust & Savings Bank of Chicago and the Union Trust Savings Bank of Chicago. Petitioner borrowed from these bankers $75,000 in October and $20,000 in December. It owed these banks $95,000 at December 31, 1919. On January 31, 1919, it paid off $25,000 of indebtedness which it had previously contracted. In order to facilitate the loans from the banks to petitioner, the general manager of petitioner took Collins with him to the bank when the loans were solicited. Collins informed the bank that the loans as a business proposition might be made with safety, and partly as a result of his representations the loans were negotiated without collateral or personal endorsement. The loans bore interest at the legal rate. At the time the loan was negotiated, petitioner had Liberty bonds in the amount of $15,550 and fixed assets of $150,250.62, and its balance sheet showed a surplus at the time of $90,060.68. The company, from its inception to the time the loans were requested, had shown a profit each year and the bank, incident to the granting of the loans, requested the balance sheet of petitioner.

Dr. M. L. Harris was, in 1919, a famous surgeon in Chicago, prominently connected with the Chicago Medical Association. He had and has a very large surgical practice and is now president of the American Medical Association. He devoted such time to petitioner's affairs during the year 1919 as was necessary for conferences with the general manager of petitioner and was paid a salary in the year 1919 of $2,500.

There was an acute shortage of paraffine wax and paper suitable for the requirements of petitioner, which started in 1918 and grew more severe until about the month of June, 1919. During this period the general manager of petitioner made continuous and unavailing efforts to secure wax from other concerns and visited all manufacturers who made paper suitable for the use of petitioner, but without securing a sufficient amount of paper for petitioner's increased requirements. Petitioner during the year 1919 had contracts for a large amount of paper and wax, but it desired additional paper and wax to meet the increased demands for its finished product. In this situation, the general manager appealed to Harris for assistance. Petitioner had a contract with the Standard Oil Co. of Indiana for paraffine wax and through the efforts of Harris, who introduced the general manager to the vice president of the Standard Oil Co., which introduction was made in the latter part of 1918, the latter company agreed to increase the amount of paraffine wax which it supplied petitioner. Petitioner used $237,138.87 worth of paraffine wax in 1919, of which $221,022 was purchased in that year. Of this amount, approximately $50,000 may be traced to the increased supply which was secured from the Standard Oil Co. of Indiana, as a result of the efforts of the general manager and of the introduction of the general manager to the vice president of the company by Harris. Petitioner used, during the year 1919, $602,595.73 worth of paper, of which $569,910.06 was purchased in that year. One hundred thousand dollars to $125,000 worth of this paper was secured as the result of the intercession of Harris, by speaking to the various paper concerns, or the introduction of the general manager of petitioner to the responsible officials of such paper companies. The paper cost about the same as other paper contracted for during the year 1918. The profit on it was practically the same during the year 1919, except that the ratio of profit was probably increased, due to the fact that overhead was but little greater as a result of the increased business.

R. B. Donnelley was connected with petitioner from its organization and was its secretary and general manager during 1919, was the most active executive of the corporation until 1919 and since August, 1921, has been its president. He was paid a salary during the year 1919 of $7,700 and was paid a salary in the year 1918 of $5,637.50. No stockholder of the company ever received any commission on the business secured as the result of his efforts.

The total salaries to officers and directors of petitioner for the year 1919 were $29,384.63, of which Andrew Christ, president, drew $11,967.05, and for seven months of the year the latter devoted one-fourth of his time to the business and for the remaining five months all of his time to the business of petitioner. During the year 1919 Christ was also general manager of the Consumers' Co., the largest distributor of coal and ice in the Middle West.

R. C. Constantine, who owned 114 shares of stock of petitioner, was sales manager of petitioner during the year 1919 and was paid a salary of $4,876.60. He devoted his entire time to sales duties. In the year 1918 he received a salary of $3,465.

All stockholders were adequately paid for the amount of time they devoted to the service of petitioner.

Petitioner had a taxable net income for 1919, as determined by respondent, of $198,268.14. It had gross sales in the year 1919 of $1,331,821.68. The gross sales of petitioner during the year 1920 were $1,339,225.83. It paid to brokers and territory salesman as commissions in that year, 1919, the sum of $32,973.69, a portion of such commissions being paid to the Biscuit & Crackers Manufacturers Purchasing Co.

OPINION.

MILLIKEN: Special assessment is claimed by the petitioner on the ground that the influential character of its stockholders and their willingness to exert that influence in its behalf, without specific compensation therefor, constitutes an abnormality. It is not contended that recourse should be had to section 327 because of inadequate salaries paid during the year to the officers and directors; indeed, counsel for petitioner requested in his proposed findings of fact that we find as a fact, which we have done, that the officers and directors were adequately paid for the amount of time they devoted to the service of petitioner. It is contended that Peabody, Collins, Sullivan, and Harris placed at the disposal of petitioner influence, not time.

Petitioner argues that because the named stockholders and officers placed at its disposal financial, industrial and political influence, and as a consequence some additional business resulted during the year therefrom, we should conclude that the showing of such a fact is sufficient to meet the test of the statute of a resultant abnormality.

We do not doubt that the influence exerted along the lines stated placed the petitioner in a favorable status to some extent, as concerns the retention of old business, increased business with their then customers, and new business to be obtained. An analysis, however, of the volume of business done during the year 1919 renders it impossible to determine any definite and fixed percentages directly attributable to the stockholders' and directors' efforts and intercessions. Many of their customers during the year, such as the William Wrigley, Jr. Co. and the Schultz Bread Co. were old customers not representing new business and some of their business, as counsel admits, would have been enjoyed in the ordinary course of business quite apart from any influence exerted by the stockholders and directors. But even admitting the postulate upon which counsel for petitioner bases his claim and attributing the entire business done during the year with the Wrigley Co., Schultz Bread Co., Sawyer Biscuit Co. and the Biscuit & Crackers Manufacturers Purchasing Co. as attributable to the influence of the stockholders and directors, and comparing the same with the gross business done during the year, we find the former representing approximately 17 per cent of the latter, which we do not believe causes an abnormality and justifying recourse to section 327 for the computation of the excess-profits-tax liability for the year.

So far as we are informed, the business of petitioner, as concerns the usual and ordinary expenses incurred or paid during the year incident to the earning of its income, such as wages for employees, commissions and salaries to officers for the time actually devoted to the affairs of petitioner, does not differ from that obtaining in the ordinary business concern, and the interest manifested by the stockholders and directors may be regarded as the usual situation obtaining with corporations in general. They had a stockholders' investment to husband and increased earnings would inure as a result of profitable business done. A 20 per cent dividend was declared in the year, not an insignificant return for stockholders. It would be a singular situation, bearing in mind the facts obtaining, if the stockholders and directors had not done as they did in helping and improving the business prosperity of petitioner. Their self-interest should compel such action, even if the general business welfare of the corporation of which they were directors and officers did not. The influence exerted by them does not constitute an abnormality so that the case should be brought under section 327 in order to relieve petitioner of an exceptional hardship.

We are not convinced, aside from its limited application based upon the facts in this case, that the abnormality claimed should be recognized as a ground for special assessment, for the legislative history of sections 327 and 328 of the Revenue Act of 1918, as well as the words of the statute itself, signify an intent of general application so as to endeavor to equalize the burden of excess-profits taxes as between a corporation practicing conservative financing and one indulging in overcapitalization. See sections 327 and 328 and Report No. 767 of the Committee on Ways and Means and Report No. 617 of the Committee on Finance to accompany H.R. 12863 (Revenue Act of 1918).

Judgment will be entered for the respondent.