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R. Gsell & Co., Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentR. Gsell & Co. v. CommissionerDocket No. 69106April 13, 1960, Filed
United States Tax Court *174Decision will be entered under Rule 50 .1.
Held , on the record as a whole, petitioner allowed its earnings and profits to accumulate beyond the reasonable needs of its business during 1947 through 1950, and 1952, and was availed of during those years to prevent the imposition of surtax upon its shareholders.2. Reasonable additions to petitioner's bad debt reserve determined for the years 1947 and 1949.
3. Where petitioner made an addition to its bad debt reserve on the basis of a specific doubtful account, and that account was subsequently collected,
held , petitioner was not required to take into income that portion of its bad debt reserve attributable to that specific account.Francis J. Rogers, Esq ., for the petitioner.Charles B. Markham, Esq ., for the respondent.Tietjens,Judge .TIETJENS*41 This proceeding involves deficiencies in income tax for the years and in the amounts as follows:
Year Deficiency 1947 $ 15,588.30 1948 5,890.72 1949 6,397.34 1950 3,341.65 1951 975.38 1952 11,887.51 The issues for decision are: (1) Whether petitioner was availed of during the years 1947 through 1950, and 1952, to prevent the imposition of surtax upon its shareholders; (2) whether the amounts of $ 5,222.43 *175 and $ 1,887.73 were reasonable additions to petitioner's bad debt reserve in 1947 and 1949, respectively; and if so (3) whether that reserve should be reduced, and petitioner's income proportionately increased, in 1951 and 1952 to reflect recovery of amounts previously charged to the reserve.
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts are so found, and are incorporated herein by this reference.
R. Gsell & Co., Inc. (hereafter referred to as the petitioner), a New York corporation, filed its Federal income tax returns for the years 1947 through 1951, with the collector of internal revenue for the third district of New York. Its 1952 return was filed with the district director of internal revenue, Upper Manhattan District, New York.
Roland Gsell (hereafter referred to as Gsell) has always been petitioner's president, principal stockholder, and chairman of its board of directors. During the years in issue, he owned 9,998 of its 10,000 shares of common stock, and 862 of its 1,000 shares of class B stock. *42 His wife owned 1 share of the common, and, with other members of the Gsell family, owned 61 shares of the class B stock. The Mt. Vernon Watch Company, a corporation *176 controlled by the Gsell family, owned 44 shares of petitioner's class B stock.
Gsell was trained in the watch business as a young man. He always has taken an active part in the industry, and enjoys considerable standing in the trade. In 1922 he organized the petitioner. Since that time it has engaged in purchasing, importing, assembling, and selling Swiss watch movements and watches. Operationally, its activities are carried on in two departments; a merchandising department and a commission department.
In its merchandising operation, petitioner imported from Switzerland complete watches and watch movements. At its New York factory, the imported movements, along with American-made cases and watch bands, were assembled into finished watches. It then undertook the sale of this finished product to several hundred customers, including wholesalers, department stores, and other retail outlets. Ordinarily, assemblage of a watch took only a few days time, the work being done by a work force of three to five watchmakers. Sales were made throughout the country by four or five salesmen on a salary-plus-commission basis. Normally, there was a constant turnover in inventory, orders being filled *177 as rapidly as possible.
The Swiss concerns from which petitioner acquired its watch movements were organized in a rigidly controlled cartel or syndicate. These concerns neither would nor could contract for a definite delivery date or a fixed purchase price. Until notified by the Swiss manufacturer, petitioner did not know when an order would be delivered. During 1947 and 1948, deliveries were 11 to 24 months behind orders. By the date of this trial, this time lag had been reduced to 8 months. Outstanding orders were never shipped all at one time. Petitioner gauged its current orders by the sales anticipated in the following year.
United States Customs required all imported watch movements to bear the importer's customs symbol and his trademark. Because these were stamped on the watch plates at the outset of production, orders placed with a Swiss factory could not be canceled. An attempt to cancel would result in blacklisting by the industry.
Upon advice that an order was ready for shipment, petitioner had 8 days to pay the purchase price in order to avail itself of a 5 per cent discount. Thirty-day payments were afforded a discount of 4 per cent. Usually, petitioner paid the *178 amount due 2 or 3 days after notification of shipment. Immediately upon arrival of the merchandise in this country, petitioner was required to pay the customs duty due on the shipment. On its books, petitioner did not *43 carry as a liability the anticipated expense for the purchase price and duty due on outstanding Swiss orders.
During 1947 and 1948 delivery of watchcases, ordered from American manufacturers, ran approximately 2 years behind orders. To effect a rapid inventory turnover, petitioner attempted to dovetail the case and movement arrivals. Because its principal product was an assembled watch, the forward placing of orders for movements, cases, and other supplies was an essential part of petitioner's business.
During the war and post-war years, petitioner's commission business produced a substantial part of its annual income. In this segment of its business, petitioner, acting as agent for several Swiss watch manufacturers, arranged the sale of their watches to large outlets in this country. On each sale petitioner received a direct commission from the manufacturer. Its customers included the four major mail-order firms in this country: Montgomery Ward, Alden, Sears and *179 Roebuck, and Spiegel. Throughout the years, these were loyal customers. However, petitioner always feared a reduction in orders, or a personnel change which might result in these customers turning to some other source for their watches.
There was a relation between petitioner's commission and merchandising departments. Merchandising kept petitioner in touch with the market and the watch industry. Thus it was able to give its commission customers market and style advice. Merchandising inventory enabled petitioner to supply commission customers with finished watches at acceptable prices in the event these customers ran short. These were "accommodation sales," and produced little or no profit. They were made to gain, or hold, the goodwill of the commission customer.
At the annual meeting of petitioner's stockholders, the chairman of its board of directors reported on the business for the past year, and the outlook for the coming year. These reports, prepared by Gsell without assistance or advice from counsel or accountants, were included in the minutes of the annual meetings. Excerpts from these reports are set forth below:
March 25, 1946
We are particularly happy to enter a year *180 when there will be no gross profits tax to pay; a tax which has been extremely heavy on firms of our type. It has not permitted us to make the reserves and accumulation of profit which we should make during these troubled times.
May 19, 1947
The Chairman in his report indicated that business for 1946 has been satisfactory and although some distinct uncertainty loomed at the beginning of this year regarding the business for 1947, indications now are distinctly favorable.
The firm purchased $ 25,000 worth of certificates of indebtedness, and made a profit of $ 2,593.71 on its stock purchases. * * * These investments are considered *44 as having a temporary character, as it is fully realized that these monies will be needed in the business sooner or later.
March 29, 1948
The Chairman in his report indicated again that the year 1947 was very satisfactory, but, that the prospects for 1948 looked very doubtful. Like everybody else, our expenses are much higher and a drop in sales would soon have a distressing effect upon the whole situation. The customers have become much more choosy, while the Swiss suppliers are not shipping the way they should. We expect the situation to straighten out during *181 the latter part of the year.
The Chairman stated that the corporation has been considering paying back the Preferred stock, but, that it has been decided to wait, because, while finances are favorable, the future is too unclear. We have had so many years of difficulty in financing our business that it was decided, in view of the situation and the definite prospect of having to carry large stocks and extend longer credits to our customers, all of which will strain our finances, to wait another year or two to see what happens, before taking the step in question. For the same reason it was deemed not advisable to declare any dividends. The tax situation has improved somewhat and permits us to strengthen our liquid assets position, which should in turn permit us relatively soon to take some of the steps contemplated above.
March 28, 1949
The Chairman in his report stated that the trade situation has changed entirely. There are liquidations at cost and below cost all over the country and while we are in a position to take care of all the orders placed, we review with alarm the income account due to the drop in sales.
March 27, 1950
The Chairman reported that conditions in the trade had not *182 been favorable at all this year. The liquidation of distressed merchandise reported at the last annual meeting has kept up. In fact, they have increased greatly, with no sign of betterment. Sales below cost, over-stocks, etc. have disrupted the trade considerably and now seem to have actually created a great fear in the minds of the buyers and sales are becoming increasingly poor. * * *
On the other hand, the Chairman reported that the direct import department is working very well and it is due to this department that the net operation for the year can close with a profit.
March 27, 1951
The Chairman reported that conditions in the trade continued to be unfavorable during the entire year. Sales of merchandise at either slightly below or slightly above landed cost was the rule throughout the country, and they are very difficult to explain. These sales might be connected with illegal entry into this country. In the meantime, they have depressed the whole market for non-advertised watches. These circumstances have brought about a substantial loss in what we call our "merchandising department." The over-all more favorable figure is due to the excellent returns on what we call our "direct *183 import department." The total over-all profit, is far from being satisfactory.
March 26, 1952
The Chairman reported that the conditions in the trade mentioned at the last annual meeting have been exactly the same, if not worse during 1951. * * * Our sales have been worse than during the 1932 depression. * * * The conclusion is that a re-alignment of some type is long overdue. If it was not for the normal returns of the Direct Import department, the firm would be deeply in *45 the red and would have been forced to take drastic action long ago. It is very unbusinesslike for one department to maintain the other. * * * There was a time when one might and could have figured that this bad period was temporary and had to be expected and accepted with the good results of other years, but, these conditions have been going on now for several years and there is no expected improvement in sight so far.
Throughout its history, petitioner has considered its primary business to be merchandising. During and immediately after World War II, the watch industry experienced a strong sellers market. Customers were plentiful, and all sales were for cash. By the late 1940's and early 1950's, a noticeable *184 recession occurred within the industry. Sales dropped, and the cash customer was replaced by the credit customer. In 1952, petitioner began to look for other sources of revenue. While it always had dealt in the higher priced jewellever watches, at this time it arranged to sell a less expensive pinlever watch. First sales of this watch took place in 1953. Sales increased steadily through 1956.
On June 30, 1947, petitioner's outstanding orders for watch movements amounted to $ 244,855. Duty payable thereon was $ 96,021. Also, it had $ 56,767 worth of outstanding orders for cases and boxes.
Petitioner's gross sales, gross profit from sales, commissions, other income, expenses other than for cost of goods sold, pre-tax net income, and tax liability for the years 1947 through 1952, as set forth on its tax returns were:
Gross sales Gross profit Commissions Other income 1947 $ 522,242.97 $ 125,731.43 $ 56,488.72 $ 10,054.87 1948 352,374.82 65,505.74 59,420.50 11,967.49 1949 188,772.70 42,432.52 59,718.90 5,762.46 1950 141,960.36 28,715.05 68,613.90 2,852.01 1951 100,751.00 17,870.93 64,153.87 1,647.66 1952 200,039.95 19,021.11 82,771.35 4,237.22 Expenses *185 Pre-tax Tax net income liability 1947 $ 121,327.29 $ 70,947.73 $ 26,911.69 1948 107,842.61 29,051.12 7,728.15 1949 84,461.88 23,452.00 5,299.25 1950 85,516.51 14,664.45 3,372.82 1951 80,822.00 2,850.46 819.51 1952 82,316.86 23,712.82 6,881.80 Its selling and general expenses (as stipulated), pre-tax merchandising net profit (loss), and its net pre-tax profit and surplus for each of the years 1947 through 1952 were:
Selling and Merchandising Net pre-tax general net profit profit Surplus expenses (loss) 1947 $ 136,454 $ 25,563 $ 70,947 $ 116,108 1948 123,433 (32,179) 27,720 136,139 1949 97,778 (33,828) 23,452 145,113 1950 94,854 (49,878) 14,719 157,812 1951 89,746 (55,604) 2,545 158,047 1952 88,202 (56,523) 23,821 168,157 Petitioner charged all overhead expenses of these years to its merchandising department.
At all times material hereto, petitioner's stated capital was $ 150,000.
*46 Petitioner's gross sales, selling and general expenses, net pre-tax profit, and surplus for each of the years 1922 through 1946 and the years 1953 through 1956 were:
*186Year Gross sales Selling and general Net pre-tax Surplus expenses profit (loss) (deficit) 1922 $ 600,584 $ 74,172 $ 48,576 1923 511,687 (14,228) 21,572 1924 407,104 1,576 31,572 1925 500,641 (85) 23,647 1926 588,623 10,796 43,423 1927 500,926 4,948 43,276 1928 451,696 6,569 44,145 1929 655,429 20,741 57,586 1930 400,724 (6,488) 44,836 1931 176,833 (28,489) 16,251 1932 80,188 (50,131) (48,879) 1933 82,077 (13,808) (62,687) 1934 165,637 (2,472) (65,159) 1935 139,711 (679) (66,339) 1936 163,078 1,433 (65,156) 1937 134,544 132 (65,023) 1938 80,152 (2,029) (67,081) 1939 91,707 (839) (67,920) 1940 94,866 1,248 (66,671) 1941 204,362 $ 57,273 17,231 (53,810) 1942 454,109 99,918 42,538 (33,224) 1943 480,879 102,623 53,881 (13,802) 1944 338,806 99,802 45,359 7,676 1945 451,573 131,215 45,743 29,449 1946 469,621 123,232 68,954 71,128 1953 90,797 93,772 173,008 1954 133,057 106,607 173,956 1955 325,238 143,535 174,769 1956 406,005 134,335 176,372 Petitioner's monthly cash expenditures for each of the years 1947, 1948, and 1949 were:
1947 1948 1949 January $ 62,060.91 $ 45,966.62 $ 27,902.43 February 23,959.33 18,807.13 24,226.00 March 30,737.91 36,588.13 39,533.82 April 53,867.60 80,774.89 29,412.38 May 39,409.37 69,551.56 57,459.90 June 40,712.65 95,613.59 46,790.88 July 37,069.01 60,098.88 34,414.55 August 33,883.74 39,518.83 25,906.34 September 70,372.78 70,724.94 46,385.58 October 42,277.27 63,397.82 41,743.18 November 57,724.79 63,399.75 21,421.69 December 72,698.99 63,233.19 55,819.38 564,774.35 707,675.33 451,117.24 On its returns for each of the years 1947 through 1952, petitioner computed its cost of goods sold in the following manner:
1947 1948 1949 Opening inventory $ 73,917.92 $ 72,717.48 $ 145,702.54 Manufacturing expense 5,094.55 3,393.45 1,379.93 All purchases 280,700.95 237,948.42 95,306.46 Shop salaries 10,236.41 10,866.97 8,197.80 Duty 99,279.19 107,645.30 58,663.57 Total 469,229.02 432,571.62 309,250.30 Less closing inventory 72,717.48 145,702.54 162,910.12 Cost of goods sold 396,511.54 286,869.08 146,340.18 1950 1951 1952 Opening inventory $ 162,910.12 $ 119,621.08 $ 79,100.45 Manufacturing expense 1,407.01 892.54 564.12 All purchases 32,134.30 27,224.15 104,408.93 Shop salaries 7,716.00 7,364.50 5,229.76 Duty 28,698.96 6,878.25 38,972.86 Total 232,866.39 161,980.52 228,276.12 Less closing inventory 119,621.08 79,100.45 47,257.28 Cost of goods sold 113,245.31 82,880.07 181,018.84 *47 *187 Its inventory as of December 31, 1946 through 1952, was composed of the following items:
1946 1947 1948 1949 Complete watches $ 13,325.39 $ 32,019.60 $ 48,947.05 $ 41,325.15 Watch cases 12,606.76 11,142.83 14,605.49 14,188.30 Movements 43,721.37 26,064.68 70,802.68 99,949.63 Material and dials 719.40 1,103.00 2,572.78 1,831.82 Attachments 3,462.00 2,304.37 3,106.94 2,302.02 Miscellaneous diamonds and watches 83.00 83.00 5,667.60 3,313.20 Total 73,917.92 72,717.48 145,702.54 162,910.12 1950 1951 1952 Complete watches $ 32,165.10 $ 20,869.70 $ 13,865.58 Watch cases 12,236.40 13,420.84 9,715.04 Movements 68,283.70 38,766.03 19,700.16 Material and dials 1,586.20 2,002.13 950.03 Attachments 2,492.92 2,488.35 1,929.42 Miscellaneous diamonds and watches 2,856.76 1,553.40 1,097.05 Total 119,621.08 79,100.45 47,257.28 Since its organization, petitioner has made no loans or advances to either Gsell or members of his family, or any other stockholder, save a temporary advance of $ 9,000 made Gsell in 1945. This advance was repaid within the space of a few months.
Gsell and his wife owned stock in three Swiss watch companies. Beginning in 1940 and continuing through the years in issue, Gsell made repeated efforts to have the management of these companies increase *188 the dividends payable upon their shares. These efforts were successful, the Gsells receiving the following dividends on these stocks during the years 1942 through 1952:
1942 $ 3,026 1943 2,842 1944 2,691 1945 2,080 1946 2,080 1947 2,664 1948 $ 5,287 1949 2,968 1950 10,819 1951 13,641 1952 16,317 From its organization through 1930, petitioner paid dividends in only 3 years. No dividends were paid during the years 1931 through 1950. A dividend of $ 5,000 was paid in 1951, and one of $ 7,000 was paid in 1952.
On December 31, 1946 through 1952, in addition to its inventory, petitioner held the following receivables, cash balance, and investments:
Dec. 31 -- Receivables Cash balance Investments 1946 $ 190,912 $ 21,828 $ 30,035 1947 185,409 44,381 35,227 1948 102,018 52,161 33,275 1949 66,227 65,209 28,908 1950 67,205 129,548 25,156 1951 27,294 145,763 78,987 1952 21,780 115,714 170,339 Among the investments held in 1951 were $ 33,987 in bonds of American Telephone & Telegraph Co., and $ 45,000 in United States Treasury notes. In 1952 they included $ 40,574.48 in American Telephone & Telegraph bonds, 200 shares of American Telephone & Telegraph stock valued at $ 29,764.63, and $ 100,000 in United States*48 Treasury debentures. The American*189 Telephone & Telegraph stock was sold in 1956. The receivables included the following commissions due from Swiss firms as of December 31, 1947 through 1952:
Unpaid Dec. 31 -- commissions 1947 $ 33,133.39 1948 17,940.67 1949 14,963.60 1950 $ 30,078.05 1951 13,578.16 1952 10,416.85 Commissions were ordinarily paid 2 to 4 months after they were earned. The balance of the receivables included merchandising accounts usually settled in 4 to 6 months' time.
On December 31, 1947 through 1952, petitioner's books and records revealed the following current assets and current liabilities, the latter being exclusive of outstanding commitments for purchases:
Current Current assets liabilities 1947 $ 347,988.19 $ 62,006.28 1948 333,330.54 27,355.01 1949 323,430.31 16,485.87 1950 $ 341,744.22 $ 17,954.69 1951 331,297.03 6,988.02 1952 356,238.06 21,864.28 During the depression years, petitioner and its president experienced difficulty in obtaining bank financing. Loan requests were either refused, or, if granted, were severely restricted in amount and term. Creditors imposed rigid requirements as to petitioner's inventory and salary policy. Because of these difficulties, petitioner decided to forego the use of bank credit in its business. *190 It determined that thereafter it would use its own resources to finance operations. However, on occasions it borrowed funds from the Mt. Vernon Watch Company; borrowing the amount of $ 50,000 in 1945, $ 50,000 in 1946, and $ 10,000 to $ 27,000 in 1947.
Petitioner's officers and directors were paid the following salaries and commissions during the years 1947 through 1952:
Roland Gsell John Zwygart Freya Gsell Salary Salary Salary Commission 1947 $ 11,800 $ 8,255.42 $ 8,580 $ 600 1948 11,100 8,920.28 7,660 600 1949 7,300 7,112.98 6,250 200 1950 10,500 8,929.88 7,030 400 1951 10,500 8,214.24 7,030 400 1952 10,600 10,895.61 7,130 400 Roland Gsell filed an individual Federal income tax return for the taxable year 1947. He filed joint returns with his wife, Freya, for the taxable years 1948, 1949, 1950, and 1952. On these returns were reported adjusted gross income and tax liabilities in the following amounts: *49
Year Adjusted Tax liability gross income 1947 $ 34,410.39 $ 11,363.69 1948 41,869.04 9,020.30 1949 40,194.56 8,769.44 1950 44,578.92 8,604.22 1952 52,589.79 12,164.54 In computing the deficiencies herein, respondent determined petitioner had the following undistributed
section 102 net income:1947 $ 47,953.58 1948 20,250.23 1949 19,615.96 1950 $ 11,703.78 1951 none 1952 17,287.56 Had *191 petitioner distributed its determined "undistributed
section 102 net income" during each of the years in issue, Gsell's personal tax liability would have been increased in the following amounts:Year Increase 1947 $ 33,446.59 1948 10,092.38 1949 9,543.97 1950 $ 5,949.36 1952 11,937.48 The parties have stipulated that the distribution in each of the years in issue by petitioner of its determined "undistributed
section 102 net income" would have produced the following effect on its financial position:Year Net worth Inventory Receivables Cash and Current investments liabilities 1947 $ 218,155 $ 72,717 $ 185,409 $ 31,655 $ 62,006 1948 217,936 145,702 102,018 17,233 27,355 1949 207,295 162,910 66,226 6,299 16,485 1950 208,291 119,621 67,206 55,183 17,954 1951 208,526 79,100 27,294 125,229 6,988 1952 201,349 47,257 21,780 169,245 21,864 1953 206,200 83,490 25,705 134,325 22,958 1954 207,148 129,097 35,301 77,158 19,191 1955 207,961 197,146 86,312 (11,934) 56,802 1956 209,564 89,895 118,732 14,051 13,986 At all times material hereto, petitioner used the reserve *192 method of bad debt accounting. For the years 1929 through 1946 its gross sales, losses on merchandising accounts, and bad debt reserve balance, as of December 31, were:
Gross Actual Dec. 31 Year sales losses reserve balance 1929 $ 655,429 $ 16,978.40 $ 1,598.32 1930 400,724 3,281.83 2,323.74 1931 176,833 3,660.28 2,200.10 1932 80,188 5,863.19 1,745.45 1933 82,077 4,030.34 997.79 1934 165,637 1,454.70 1,162.45 1935 139,711 1,090.85 1,419.23 1936 163,078 1,190.13 995.66 1937 134,554 1,095.47 532.83 1938 $ 80,152 $ 582.73 $ 329.86 1939 91,707 332.54 370.80 1940 94,866 606.42 737.50 1941 204,362 5,778.65 1942 454,109 5,778.65 1943 480,879 5,778.65 1944 338,806 5,778.65 1945 451,573 5,778.65 1946 469,621 10,474.07 *50 Its gross sales, accounts receivable as of December 31, additions to its bad debt reserve, losses on its merchandising accounts, and reserve balance as of December 31, for each of the years 1947 through 1952, were:
Dec. 31 Additions to Dec. 31 Year Gross sales accounts reserve Actual losses reserve receivable balance 1947 $ 522,242 $ 185,409 $ 5,222.43 $ 15,696.50 1948 352,374 102,018 15,696.50 1949 188,772 66,227 1,887.73 $ 5,273.74 12,310.49 1950 141,960 67,205 12,310.49 1951 100,751 27,294 *193 3,952.74 16,263.23 1952 200,039 21,780 1,321.00 17,584.23 Included in petitioner's 1947 accounts receivable was an account of the Beck Jewelry Enterprises which totaled $ 22,000. At the close of 1947 it was extremely doubtful whether this account would ever be satisfied. In 1949, $ 10,547.10 was still owed petitioner on the Beck account, and the account still appeared doubtful. One-half of this amount, $ 5,273.74, was considered uncollectible by petitioner, and was written off as a bad debt by a charge to its reserve in 1949. Further, petitioner made an addition to its bad debt reserve in 1949 of $ 1,887.73.
In 1950, Leon Beck guaranteed a note of Beck Enterprises in the face amount of $ 10,547.10 issued to petitioner. This note was payable in 24 monthly installments of $ 440.32. The sum of $ 3,952.74 was paid on this note in 1951, and $ 1,321 in 1952. Both these amounts, when received by petitioner, were added back to its bad debt reserve under an adjustment labeled "Recovery." This account was finally paid in full in 1952.
Among petitioner's receivables for 1947 and 1949 were commissions due from Swiss firms in the respective amounts of $ 33,133.39 and $ 14,963.60. These amounts were subject to possible loss due to devaluation *194 of the Swiss franc, restriction on exchange rates, or political occurrences. During an undisclosed period petitioner was forced by the Swiss Government to collect these commissions at the official rate of exchange of 23 cents, when the franc was worth 40 cents in the free market. Otherwise, it never lost any money on its foreign commission accounts.
On its returns for the years 1947 and 1949, petitioner deducted, as bad debts, the additions to its reserve of $ 5,222.43 and $ 1,887.73, which represented 1 per cent of its gross sales in each such year. Respondent determined these were unreasonable additions to its bad debt reserve, and accordingly disallowed the deductions. He further determined:
*51 In the event that the deductions as claimed are found reasonable, it is held, in the alternative, that the reserve for bad debts should be decreased and income increased in the amounts of $ 2,395.83 and $ 13,730.68 in the years 1951 and 1952, respectively, inasmuch as the accounts receivable against which these amounts had been set up had been collected, and for the further reason that the reserve is deemed excessive as indicated by the following schedule:
Balance Per Return December 31, 1951 December 31, 1952 Accounts Receivable $ 13,867.40 $ 12,510.02 Reserve for Bad Debts 16,263.23 17,584.23 On *195 November 13, 1956, respondent notified the petitioner of an intention "to issue a statutory notice of deficiency for the years 1947, 1948, 1949, 1950, and 1952 setting forth an amount with respect to
section 102 of the Internal Revenue Code of 1939 relating to surtax upon corporations improperly accumulating surplus." On December 11, 1956, petitioner submitted a 24-page statement, pursuant to the provisions ofsection 534 of the Internal Revenue Code of 1954 , setting forth the grounds, and supporting facts, upon which it relied to establish that its earnings and profits had not been permitted to accumulate beyond reasonable business needs. That statement is incorporated herein by this reference. On May 15, 1957, respondent mailed a statutory notice of deficiency to petitioner.Petitioner's earnings or profits were permitted to accumulate beyond the reasonable needs of its business in each of the years 1947 through 1950, and in 1952.
OPINION.
Respondent determined petitioner was availed of in the years 1947 through 1950, and 1952, to prevent the imposition of surtax upon its shareholders, by accumulating, rather than dividing or distributing, its earnings and profits, all within the *196 meaning of
section 102 of the Internal Revenue Code of 1939 . *197 of the evidence. In the final analysis however, reasonableness of the accumulation is merely a subsidiary consideration, the ultimate question being whether the taxpayer was availed of for *52 the purpose proscribed by the statute. , on appeal (C.A. 1). Thus, it may well be that a taxpayer was not availed of to avoid the surtax during a particular year, even though the accumulation in that year was clearly beyond reasonable business needs.Young Motor Co ., 32 T.C. 1336 (1959) .Gus Blass Co ., 9 T.C. 15 (1947)Throughout our discussion, we have assumed petitioner had shifted the burden of proof to respondent, insofar as its reasonable business needs were concerned, by virtue of the statement of grounds and facts which it filed pursuant to the provisions of
section 534 of the 1954 Code. *207 We have reached our conclusions as to its reasonable *56 business needs on the basis of affirmative *206 facts of record. Thus, we need not consider the sufficiency of petitioner'ssection 534 statement.By way of an alternative, should either addition to the reserve be found reasonable, respondent contends that that portion thereof attributable to the Beck account must be taken into income in 1952, the year in which the account was finally collected in full. Originally he determined under this theory that petitioner should report as ordinary income the amounts of $ 2,395.83 and $ 13,730.68 in 1951 and 1952, respectively. He now concedes error as to that determination, and in light of our holdings above, would require only that $ 5,222.43 be added to petitioner's income in 1952. We do not agree. Respondent's own regulations *212 in the law or cases, which would justify respondent's present position.
Footnotes
1. As per petitioner's books without adjustments proposed by respondent other than with respect to
section 102↩ income.2. As per company's books without reflection of commitments to Swiss watch factories.↩
1. Recovery of amount charged off in 1949.
1.
SEC. 102 . SURTAX ON CORPORATIONS IMPROPERLY ACCUMULATING SURPLUS.(a) Imposition of Tax. -- There shall be levied, collected, and paid for each taxable year (in addition to other taxes imposed by this chapter) upon the net income of every corporation * * * if such corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders or the shareholders of any other corporation, through the medium of permitting earnings or profits to accumulate instead of being divided or distributed, a surtax * * *
* * * *
(c) Evidence Determinative of Purpose. -- The fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid surtax upon shareholders unless the corporation by the clear preponderance of the evidence shall prove to the contrary.↩
2.
SEC. 534 . BURDEN OF PROOF.(a) General Rule. -- In any proceeding before the Tax Court involving a notice of deficiency based in whole or in part on the allegation that all or any part of the earnings and profits have been permitted to accumulate beyond the reasonable needs of the business, the burden of proof with respect to such allegation shall --
(1) if notification has not been sent in accordance with subsection (b), be on the Secretary or his delegate, or
(2) if the taxpayer has submitted the statement described in subsection (c), be on the Secretary or his delegate with respect to the grounds set forth in such statement in accordance with the provisions of such subsection.
(b) Notification by Secretary. -- Before mailing the notice of deficiency referred to in subsection (a), the Secretary or his delegate may send by registered mail a notification informing the taxpayer that the proposed notice of deficiency includes an amount with respect to the accumulated earnings tax imposed by
section 531 . * * *(c) Statement by Taxpayer. -- Within such time (but not less than 30 days) after the mailing of the notification described in subsection (b) as the Secretary or his delegate may prescribe by regulations, the taxpayer may submit a statement of the grounds (together with facts sufficient to show the basis thereof) on which the taxpayer relies to establish that all or any part of the earnings and profits have not been permitted to accumulate beyond the reasonable needs of the business.
3. Regs. 118, sec. 39.23(k)-5.↩
Document Info
Docket Number: Docket No. 69106
Citation Numbers: 34 T.C. 41, 1960 U.S. Tax Ct. LEXIS 174
Judges: Tietjens
Filed Date: 4/13/1960
Precedential Status: Precedential
Modified Date: 11/14/2024