Kartsen Catering Co. v. Commissioner , 13 T.C. 645 ( 1949 )

Kartsen Catering Company, a Michigan Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent

Kartsen Catering Co. v. Commissioner

Docket No. 18212

United States Tax Court

13 T.C. 645; 1949 U.S. Tax Ct. LEXIS 56;

October 25, 1949, Promulgated

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Decision will be entered for the respondent.

Reconstruction of base period income by use of results of business for last month of base period, relied on by petitioner in claiming relief from excess profits tax, held, on facts, not sufficient to sustain petitioner's burden of meeting requirements of section 722.

Clarence A. Bradford, Esq., for the petitioner.

Wesley A. Dierberger, Esq., for the respondent.

Opper, Judge.

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OPPER

This proceeding involves the correctness of the determinations of respondent disallowing petitioner's applications for relief for the calendar years 1943 and 1944 under section 722 (b) (4) of the Internal Revenue Code. Petitioner filed applications for relief and claims for refund for 1943 and 1944 in the amounts of $ 9,942.23 and $ 8,770.31, respectively.

Relief was also sought undersection 722 for 1942, but petitioner has conceded that the proceedings relating to its claim for relief and refund of $ 7,786.67 for that year may be dismissed.

The facts were presented by a stipulation and evidence adduced at the hearing. Those facts hereinafter appearing which are not from the stipulation are otherwise found from the record.

FINDINGS OF FACT.

The stipulated facts are hereby found accordingly.

Petitioner, a Michigan corporation, was incorporated January 15, 1915, with a paid-in capital of $ 5,000. Its Federal tax returns for the years in question were filed on an accrual basis with the collector of internal revenue for the district of Michigan, at Detroit.

Petitioner was incorporated for the purpose of engaging in the general cafeteria business. During most of its existence and during all of the base period years, with the exception of the months of November and December, 1939, it was located on the second floor of a building on the southeast corner of Woodward Avenue and Clifford Street in downtown Detroit, its entrance being on Clifford Street. Petitioner operated a self-service cafeteria on these premises, with a seating capacity for 100 patrons.

Effective September 1, 1939, petitioner leased a building at 1550 Woodward Avenue in downtown Detroit for a period of 10 years and 4 months. This building was remodeled to house a self-service cafeteria on the main floor, with an entrance on Woodward Avenue. A balcony was added, making additional space available for cafeteria customers, who carried their own trays up from the serving counters on the first floor. The new cafeteria had a seating capacity for 265 patrons. The third floor of the building was remodeled into a dining room, with bar and waitress service, and had a seating capacity for 135 patrons. Petitioner began operations at 1550 Woodward Avenue in November 1939.

Petitioner's profit and loss statements for the years 1936 through 1939 are as follows:

PROFIT AND LOSS, BASE PERIOD
	1936		1937
Sales		$ 85,781.55		$ 101,287.04
Expenses:
Food cost	$ 34,242.94		$ 39,119.27
Labor	14,236.70		18,874.46
General expenses	645.42		933.41
Laundry	2,391.97		3,486.29
Advertising	411.50		591.46
Refrigeration	189.39		87.79
Janitor supplies	546.62		597.22
Beer and fountain
expense	98.18
Gas	1,710.05		1,505.35
Elevator service
Light and power	2,157.88		2,034.50
Telephone and
telegraph	190.39		186.38
Taxes	657.20		511.99
Insurance	490.35		614.59
Paper	85.94		141.12
Paint	105.45		35.55
Flowers and music	228.53		80.69
Legal
Stationery and office	142.19		109.17
Repairs	1,458.04		1,774.02
Exploitation (sic)	220.00		80.71
Rent	6,849.47		8,089.55
Office salaries	370.00		420.00
Management salaries	14,000.00		19,056.45
Depreciation	3,685.25		2,607.25
Moving expense
Total		85,076.47		100,858.22
		705.08		428.82
			* 136.77
Net income		750.51		565.59

PROFIT AND LOSS, BASE PERIOD
	1938		1939
Sales		$ 77,819.74		$ 93,366.79
Expenses
Food cost	$ 30,176.13		$ 36,420.26
Labor	16,342.01		21,729.31
General expenses	582.27		790.54
Laundry	2,518.26		3,254.96
Advertising	483.93		1,346.69
Refrigeration	114.81		101.83
Janitor supplies	693.71		730.61
Beer and fountain
expense
Gas	1,541.80		1,765.44
Elevator service			69.00
Light and power	1,857.55		2,625.60
Telephone and
telegraph	172.59		271.46
Taxes	559.05		632.03
Insurance	623.67		540.06
Paper	133.99		434.36
Paint	84.59		67.58
Flowers and music	142.40		135.83
Legal			350.00
Stationery and office	133.84		102.11
Repairs	1,063.35		654.64
Exploitation (sic)	150.00		182.84
Rent	6,214.01		5,760.13
Office salaries	420.00		725.90
Management salaries	11,604.24		11,458.00
Depreciation	2,058.02		2,895.00
Moving expense			232.13
Total		77,670.22		93,276.31
		149.52		90.48
		* 135.27		* 51.72
Net income		284.79		142.20

Petitioner's balance sheets for 1936 through 1939 disclose the following:

	12/31/36	12/31/37	12/31/38	12/31/39
ASSETS
Cash	$ 250.00			$ 1,801.67
Insurance claim				2,597.11
Inventory	643.36	$ 400.85	$ 367.55	1,968.79
Equipment	39,069.87	24,766.97	24,832.99	29,982.24
Prepaid expenses	449.38	485.25	522.99	2,724.45
1550 Woodward, equipment, etc				106,242.16
Total	40,412.61	25,653.07	25,723.53	145,316.42
LIABILITIES
Accounts payable				60,557.91
Bank overdraft	973.06	2,350.87	160.19
Loans payable				53,956.55
Accruals				2,237.02
Reserve for depreciation	27,299.71	10,670.15	12,728.17	15,623.17
Capital stock	5,000.00	5,000.00	5,000.00	5,000.00
Capital surplus	59,215.55	59,215.55	59,215.55	59,215.55
Surplus (red)	(52,826.22)	(52,149.09)	(51,665.17)	(51,415.98)
Profit and loss current year	750.51	565.59	284.79	142.20
Total	40,412.61	25,653.07	25,723.53	145,316.42

Petitioner is entitled on the invested capital basis to excess profits credits as follows:

1940	$ 7,460.69
1941	8,158.69
1942	10,237.82
1943	11,296.53
1944	11,551.34

On September 15, 1943, petitioner filed with respondent on Form 991 an application for 1942 for relief under section 722. At the bottom of page 1 of the application appeared the following:

It is not possible for the taxpayer prior to September 16, 1943, to obtain, prepare, and present all the detailed information required to establish its eligibility for relief and the amount of its constructive average base period net income and, therefore, such information will be submitted within a reasonable time after the filing of this application as a supplement to the application, pursuant to the provisions of Section 30.722-5 (a) (1) of Regulations 109.

In schedule B of the application petitioner checked paragraph 4 as the reason it was claiming the excess profits tax was excessive and discriminatory. The introductory portion of that paragraph reads as follows:

4. The business of the taxpayer was commenced or there was a change in the character of the business immediately prior to or during the base period (section 722 (b) (4)).

On June 3, 1944, petitioner filed with respondent on Form 991 an amended application for 1942 for relief under section 722, purporting to furnish the information required for relief under section 722 (b) (4). In an exhibit attached to the application petitioner set forth its business history, stating that during the base period years its business was located on the second floor premises on Clifford Street with space for only 100 patrons; that in November 1939 the business moved to 1550 Woodward Avenue with space for 400 patrons, 2 floors being devoted to cafeteria service, and a third floor to waitress and bar service; that in its new premises it occupied the entire building and had expended over $ 70,000 in remodeling it. It set forth its gross receipts, expenses, and net profit for the years 1936 through 1943. It claimed that a tax based on the use of the income during the base period years would be excessive and highly discriminatory, and that it therefore should be allowed to set up a constructive base period. The statement continued:

* * * It is our belief that a gross business of $ 420,000 should be the lowest to be used, as this business came along with this company about two years after the change became effective, and considering that this volume of business should have been expected to have been the business if the change had been effected two years before it did. With this gross of business the cost of goods would have been $ 260,000 and the expenses of business would have been $ 140,000 with a net income of $ 20,000.

This net income of $ 20,000 figured on a 95% basis would give us an excess profits credit of $ 19,000. Using this credit with the gross profits of the year 1942, there would have been no excess profits taxable income for the year 1942.

On June 5, 1944, petitioner filed with respondent on Form 991 an application for 1943 for relief under section 722, similarly indicating that it was claiming relief under section 722 (b) (4). Its exhibit in connection with the claim again relied upon the records of the business to show a large increase in the business since it became established at 1550 Woodward Avenue, and stated that a tax based on the use of income during the base period years would be excessive and highly discriminatory, calling for a constructive base period. The exhibit was substantially similar to that above set forth.

On June 2, 1945, petitioner filed with respondent on Form 991 its application for 1944 for relief under section 722. For its excess profits net income for the base period computed without regard to section 722 reference was made to "original application on form 991." Attached to Form 991 for 1944 was the following:

Exhibit with form 991 showing computation of excess profits tax by using E. P. credit based on constructive base income for calendar year 1944.

Excess Profits Net income per return		$ 55,675.68
Specific Exemption	$ 10,000.00
Ex P. Credit per constructive base period	19,000.00
		29,000.00
Adjusted E. P. net income		26,675.68
95 per cent of above		25,341.90

Petitioner filed with respondent claims for refund of its excess profits tax for 1943 and 1944 on Form 843. On the claim for 1943 the reasons stated by petitioner in support of the claim were as follows:

Pursuant to application for relief under Section 722 of I. R. C. and as per form 991 heretofore filed for this same period.

This is to correct an excessive and discriminatory tax as disclosed by the original return.

On the claim for refund for 1944 the reasons stated by petitioner in support of the claim were as follows:

Pursuant to application for relief under section 722 of the Internal Revenue Code as per form 991 heretofore filed and made a part hereof. This is to correct an excessive and discriminatory tax as per original return filed March 15th, 1944.

At the hearing and in its brief petitioner in reconstructing its base period net income took the sales shown on its books for the month of December 1939, in the amount of $ 24,922.36, its expenses, similarly appearing, of $ 22,008.38, and the resultant net profit of $ 2,953.33, and multiplied each by 12 to obtain total theoretical sales of $ 299,068.32 for the full year 1939, theoretical costs for the 12 months totaling $ 264,096.96, and the difference, $ 34,971.36, which petitioner claimed as its theoretical net profit for 1939.

Petitioner in computing its reconstructed average base period net income took its actual sales for 1939 in the amount of $ 93,366.79 as 100 per cent and then took the percentage of the actual sales for 1936 in the amount of $ 85,781.55 to the actual sales of 1939 -- the resulting percentage figure being approximately 91 per cent. This percentage figure was then applied to the theoretical profit for 1939 in the amount of $ 34,971.36 and a theoretical profit for 1936 of $ 32,131.69 was arrived at.

For 1937, by the same process, petitioner computed its sales as 108.48 per cent of its actual 1939 sales, which percentage figure when applied to the 1939 theoretical profit, resulted in its claim to a theoretical profit in 1937 of $ 37,936.93.

In 1938, following this method, actual sales were figured at 83.34 per cent of actual sales for 1939, which percentage figure when applied to the 1939 theoretical profit resulted in a claim of a theoretical profit for 1938 of $ 29,145.13.

Petitioner in determining its theoretical net profit for 1939 did not take into account the fact that its cafeteria at 1550 Woodward Avenue had just opened, nor whether December was a normal business month in downtown Detroit. Petitioner in reconstructing its base period income did not take into account any business index; it used the figures shown on its books without any change. Petitioner did not take into account what might have happened to the cafeteria business in Detroit if petitioner had been doing a gross business necessary to produce the theoretical net profit which it claims in the base period years. Nor did petitioner take into account substantially increased advertising expenditures made by it at the time the lease was entered into for the premises and petitioner opened for business at 1550 Woodward Avenue.

Officers' salaries deducted on petitioner's books for December 1939 totaled $ 375. For November, October, and September, 1939, officers' salaries were charged on petitioner's books in the amounts of $ 700, $ 1,500, and $ 2,000, respectively. For the whole year 1939 officers' salaries were deducted on petitioner's Federal income and excess profits tax return in the amount of $ 11,075. There is no showing as to why officers' salaries for December 1939 amounted to only $ 375 and substantially varied from the other months.

Petitioner paid rent of approximately $ 2,000 a month, less approximately $ 350 rent income from stores under the September 1939 lease entered into for the premises at 1550 Woodward Avenue. The basic rent for the premises increased when the business reached more than $ 83,000 a year. In 1940 petitioner paid rent in the net amount of $ 19,785. It deducted rent on its books for the month of December 1939 of $ 500 in computing its profit for that month. There is no showing why the amount of rent deducted by petitioner amounted to only $ 500 in December 1939.

An inventory adjustment was made in December 1939 in the amount of $ 888.61, which was an additional item of income. A similar adjustment was made in November 1939 in the amount of $ 716.63. No other similar inventory adjustment was made during 1939. No showing is made as to why this inventory adjustment was made in December 1939.

In November 1939 liquor costs are shown on petitioner's books as $ 735.63 and beer costs are shown as $ 63.20. In December 1939 liquor costs are shown on petitioner's books as $ 186.02 and beer costs as $ 38.05. No showing is made for the variance in the cost of liquor and beer between November and December, 1939.

Petitioner, in determining its theoretical net profit for 1939, did not take into account that the month of December included unusual items of officers' salaries, rent, inventory adjustment, and liquor and beer costs.

The facts presented to the Court by petitioner at the hearing of the case at bar to establish its constructive base period net income were not set forth in its applications for relief on Form 991, nor in its claims for refund on Form 843 for the years 1943 and 1944.

Petitioner has not established what would be a fair and just amount representing normal earnings to be used as the constructive average base period net income and it is not established that its excess profits tax without the use of section 722 is excessive and discriminatory for 1943 and 1944.

OPINION.

If we disregard respondent's contentions that petitioner's claims for refund and relief under section 722 (b) (4) failed to acquaint him with the grounds of the claims as presently advanced, or the facts to support them, ^{Blum Folding Paper Box Co., 4 T. C. 795; that petitioner's method of reconstructing a theoretical base period income fails to show that the single month chosen as a comparative was typical; or that the assumed increase in business could have been secured from competitors during the other months of the base period years, cf. 7- Up Fort Worth Co., 8 T. C. 52; if we lay to one side all these considerations, we are still met with the affirmative showing of the record that normal earnings were adequately reflected even after the business was moved and expanded in the last month or so of 1939.}

The computation relied upon assumes that December 1939 profits furnish a typical average for petitioner's increased capacity, and that they can be projected back for reconstruction purposes. Granting this for the moment, it becomes necessary to determine what those profits actually were. Petitioner's book figures are the starting point. They are said to result in a net income for the month of December amounting to $ 2,914.28, which is then multiplied by 12 and adjusted for other years.

But, as our findings show, expenses for December are understated or income overstated in four unexplained respects if the theory of an average month of expanded operations is adhered to. "Management salaries" were understated by $ 580 (the difference between the book figure of $ 375 and one-twelfth of the annual total of $ 11,458); rent by $ 1,150 representing the excess of the new monthly rental, a net of $ 1,650, over the book deductions of $ 500; and liquor and beer costs by about $ 575, taking the preceding month as a guide. In addition an "inventory adjustment" increased the gross income for December by $ 888.61 when the total for the year was only about $ 1,600, one-twelfth of which would be about $ 133, an apparent overstatement of $ 755 or thereabouts.

These items total over $ 3,000, or more than enough to convert petitioner's apparent December profit into a slight loss -- a result easily reconciled with the first month of operation in new quarters. But bearing in mind the admonition of section 722 (a) against resorting to "events or conditions" after that month, see Lamar Creamery Co., 8 T. C. 928, nothing is left upon which to support a finding that the invested capital credit allowed by respondent has resulted "in an excessive and discriminatory tax" on petitioner's earnings, even in its new establishment. Cf. East Texas Motor Freight Lines, 7 T. C. 579; Lamar Creamery Co., supra.

The denial of petitioner's claim for relief under section 722 was accordingly warranted and must be approved.

Decision will be entered for the respondent.

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Footnotes

• *. Not identified.↩

• 1. Dismissal of the proceeding, if appropriate under the Blum case, would not be for jurisdictional reasons, but on the merits. Samara v. United States (C. C. A., 2d Cir.), 129 Fed. (2d) 594; certiorari denied, 317 U.S. 686">317 U.S. 686. We are accordingly not compelled to consider that question independently of the other issues also dealing with the merits, the case having been heared in extenso without objection by respondent. Cf. Herbert Brush Mfg. Co., 22 B. T. A. 646↩.