Opinion
No. M-113.
March 5, 1934.
Lyle T. Alverson, of New York City (Johnson Shores, of New York City, on the brief), for plaintiff.
James A. Cosgrove, of Washington, D.C., and Frank J. Wideman, Asst. Atty. Gen., for the United States.
Before BOOTH, Chief Justice, and GREEN, LITTLETON, WILLIAMS, and WHALEY, Judges.
Suit by Johnson Motor Company against the United States.
Petition dismissed.
This case having been heard by the Court of Claims, the court, upon the report of a commissioner and the evidence, makes the following special findings of fact:
1. Plaintiff was organized as the Johnson Motor Wheel Company under the laws of the state of Delaware in April, 1921. By proper corporate action the name of plaintiff was changed to Johnson Motor Company on April 30, 1923. The principal office and place of business of plaintiff is at Waukegan, Ill., and since its organization it has been engaged in the manufacture of motor-wheel parts, magnetos, and outboard motors.
2. Plaintiff was organized to acquire the assets and to conduct the business of the Johnson Motor Wheel Company of Indiana, as hereinafter shown a corporation which had been engaged in the manufacture of motor wheels and magnetos since about 1918. Motor wheels were an attachment for motorizing an ordinary bicycle. The magnetos were a necessary part of said motor wheels, but were also sold separately as a side line for other purposes by the Indiana corporation.
3. In March, 1920, the business of the Indiana corporation had fallen off to such an extent that financial difficulties were encountered, and a receiver was appointed in the fall of that year. Thereafter the receiver continued to operate the plant. At the time plaintiff corporation was organized the Indiana corporation was in the process of liquidation, and the business of said defunct corporation was confined to the manufacture of replacement parts for motor wheels and magnetos. No new motor wheels were assembled after that date.
4. At some time after the organization of plaintiff in April, 1921, and prior to July 1 of that year, plaintiff acquired certain assets of the Indiana corporation under the following circumstances:
G.A. Farabaugh, who was at that time attorney for the creditors of the Indiana corporation, purchased the assets of that corporation for $60,000 at a receiver's sale in 1921. Prior to the purchase Farabaugh had entered into an agreement with the plaintiff and certain creditors of the Indiana corporation to the effect that should he be the successful bidder for the assets at the receiver's sale, he would transfer them to plaintiff for the sum of $60,000 plus the assumption of certain liabilities in the amount of $137,735.98. The assets thus acquired by Farabaugh were transferred to plaintiff pursuant to the agreement and plaintiff recorded them on its books as follows:
Accounts receivable ........... $ 12,818.52 Notes receivable .............. 10,593.96 Inventory of materials, etc. .. 65,668.66 Machinery and equipment ....... 36,600.00 Jigs and dies ................. 9,845.62 Patterns and drawings ......... 10,100.00 Small tools ................... 1,500.00 Furniture and fixtures ........ 1,850.00 ___________ 148,976.76
The liabilities assumed amounted to $147,795.37, consisting of creditors' claims as shown by the books of the Indiana corporation. Of the amount assumed, $46,379.96 was transferred to plaintiff as notes payable, $62,000 was paid by plaintiff in cash prior to the transfer, and the remainder, $39,415.41, appeared on plaintiff's opening balance sheet as accounts payable. Plaintiff subsequently paid in full the aforementioned notes payable and accounts payable.
5. The total authorized capital stock of plaintiff was $600,000 preferred and $600,000 common stock. As of July 1, 1921, such stock had been sold to former stockholders of the Indiana corporation to the extent of $115,100. In addition to the amount received from the sale of stock, plaintiff received the dividends which the creditors of the Indiana corporation had been paid by the receiver of that corporation and whose accounts had been assumed as liabilities by plaintiff. The aforementioned funds which were received from the sale of stock and from dividends of the receiver were used to pay $60,000 to Farabaugh on account of the amount bid for the property and to reduce the liabilities assumed from $147,795.37 to $85,795.37; that is, $62,000, or total payments of $122,000.
6. Plaintiff began to operate July 1, 1921, along the lines of activity theretofore carried on by the Indiana corporation. For at least one year prior to that time the motor-wheel industry had been on the decline and no new motor wheels were assembled by it after it began operations. Its business was confined to the manufacture of motor-wheel parts and materials and magnetos, and the preparation of its plans and plant for the manufacture of outboard motors, an industry which was increasing during 1921 and 1922.
7. Plaintiff's first accounting period was from July 1, 1921, to December 31, 1921. It opened its books for that period with the inventory received from the Indiana corporation which it set up at $65,668.66, consisting of motor-wheel and magneto parts and materials. During that period its purchases thereof amounted to $81,080.02 and its sales to $66,256.73. Its closing inventory at December 31, 1921, was $80,599.87.
8. Beginning in March and April, 1922, plaintiff began the manufacture and sale of outboard motors on a production basis, and thereafter it became its principal line of activity. Sales of motor wheels and parts during 1922 amounted to only $5,871.90. The closing inventory at December 31, 1922, was $128,461.44.
9. During 1923 plaintiff definitely decided to abandon the motor-wheel business and to confine itself to the manufacture of outboard motors. It accordingly notified its wholesale distributors of its decision and requested them to purchase from it the materials and parts necessary to continue service on motor wheels and parts which it had sold in prior years. After the distributors had made certain purchases, and after sales during the year of such parts and materials amounting to $4,031.46, there remained on its books at December 31, 1923, an item of $35,354.46 representing motor-wheel parts. In closing its books at December 31, 1923, it wrote off $30,000 of the foregoing amount to reduce its inventory with respect to that item to what it considered the approximate scrap value of such parts, namely, $5,354.46. Plaintiff did not thereafter engage in the motor-wheel business, except that the material heretofore referred to was sold as junk in 1924 for $3,380.08. Purchases of all items during 1923 amounted to $274,047.35, and the closing inventory at December 31, 1923, was $136,404.31, after the reduction of $30,000 as set out above.
10. The items in the several inventories referred to above consisted of raw materials, goods in process, and finished goods. All items of a like kind were kept together and commingled in such a manner as to make identification impossible either as to date of purchase or cost of a particular item, and they were indiscriminately withdrawn for use or sale without regard to the date of acquisition. It was impossible to determine whether the items on which the write-down was made by plaintiff in 1923 as set out in finding 9 were acquired from the Indiana corporation or had been acquired from other sources since its organization.
11. March 13, 1924, plaintiff filed its federal income tax return for 1923, showing a tax liability of $2,603.51 which was paid during 1924. The net income from operations (for tax purposes) for 1923 was shown on such return at $44,044.80 from which was deducted net losses totaling $25,216.70 for 1921 and 1922, thus leaving a taxable net income of $22,828.10. Cost of goods sold was reported in the return at $492,109.84, which was computed by adding together inventory at the beginning of the year ($128,461.44), purchases ($274,047.35), and manufacturing costs ($226,005.36), and deducting the closing inventory ($136,404.31) from the sum thus obtained. As set out in finding 9, the closing inventory had been reduced $30,000 on account of certain obsolete material, which had the effect of increasing the cost of goods sold and thereby decreasing net income to that extent.
12. After an audit of plaintiff's returns for 1921, 1922, and 1923, the Commissioner of Internal Revenue determined plaintiff's taxable net income for 1923 was $90,626.12 instead of $22,828.10 and the total net losses for 1921 and 1922, $16,773.49 instead of $25,216.70, as set out in finding 11. Without taking into account the adjustments contended for in this proceeding, the net loss sustained by plaintiff for 1921 and 1922 was as determined and allowed by the Commissioner. A summary of the adjustments made by the Commissioner for the three years was as follows:
1921
Net loss as shown on return .................. $ 9,577.62 Less: (1) Bad debts disallowed ........... $133.44 (2) Depreciation disallowed ........ 307.31 _______ 440.75 __________ Adjusted loss ................................ 9,136.87 ==========
1922
Net loss as shown on return .................. 18,409.28 Less: (1) Stock subscription cancelled 120.00 (2) Bad debts disallowed ......... 362.02 (3) Depreciation disallowed ...... 10,593.83 __________ 11,075.85 __________ 7,333.43 Add: (4) Allowable expenses charged to surplus ............................ 303.19 __________ Adjusted loss ................................ 7,636.62 ==========
1923
Net income as shown on return ................ 48,044.80 Add: (1) Contract written off ................... 2,500.00 (2) Bad debts disallowed ................... 118.16 (3) Inventory adjustments .................. 50,144.14 (4) Depreciation disallowed ................ 6,592.51 __________ Total ................................ 107,399.61 Less: (5) 1921 and 1922 losses ............... 16,773.49 __________ Adjusted income .............................. 90,626.12
13. In making the computation as set out in finding 12, the Commissioner determined that the cost of assets acquired by plaintiff from the Indiana corporation was $60,000 instead of $148,976.76 as recorded on its books at July 1, 1921 (see finding 4), and made the following changes from the amounts recorded on plaintiff's books:
----------------------------------------------------------------------- | Recorded | Determined | | on books | by Commissioner | Reductions | July 1, 1921 | | --------------------------|--------------|-----------------|----------- Accounts receivable ..... | $ 12,818.52 | $12,818.52 | None Notes receivable ........ | 10,593.96 | 10,593.96 | None Inventory of materials, | | | etc. ................... | 65,668.66 | 15,524.52 | $50,144.14 Machinery and | | | equipment .............. | 36,600.00 | 19,213.00 | 17,387.00 Jigs and dies ........... | 9,845.62 | Eliminated | 9,845.62 Patterns and | | | drawings ............... | 10,100.00 | Eliminated | 10,100.00 Small tools ............. | 1,500.00 | Eliminated | 1,500.00 Furniture and | | | fixtures ............... | 1,850.00 | 1,850.00 | None |--------------|-----------------|----------- Total ................ | 148,976.76 | 60,000.00 | 88,976.76 -----------------------------------------------------------------------
The following explanation was given by the Commissioner for the inventory adjustment in 1923: "(3) The examination of your books disclosed the fact that your inventory was overstated by this amount. The examining officer was unable to determine, from the records available, the exact date that this amount was written off, but the book entries show that such amount was written off during the period covered by this examination. Since the years 1921 and 1922 disclose a net loss as adjusted, which is applied against the net income for 1923, it would have the same effect for determining your correct tax liability regardless of whether it was disallowed in 1921, 1922, or 1923. This reduction of your inventory would not be allowed as an expense in either year and would not constitute a deductible loss as defined by article 141, regulations 62."
14. Depreciation was claimed by plaintiff and allowed by the Commissioner at the rate of 10 per cent. on machinery and equipment, and furniture and fixtures, and 20 per cent. on jigs, dies, tools, patterns, and drawings. The Commissioner disallowed various amounts of depreciation as set out in the summary computation in finding 12, because of the reduction in the cost of assets as shown in finding 13.
15. As a result of the various adjustments referred to above, the Commissioner assessed an additional tax of $8,724.76 for 1923, which, with interest of $1,374.14 (total $10,098.90), was paid by plaintiff February 9, 1927.
16. February 21, 1927, and February 27, 1928, plaintiff filed claims for the refund of the additional tax and interest paid as set out in finding 15, assigning as a basis therefor substantially the same errors as are assigned in its petition in this proceeding. The claims were rejected July 8, 1927, and April 24, 1928, respectively, and such claims have not been paid either in whole or in part.
This is a suit for the recovery of $10,098.90 representing income tax and interest paid by plaintiff February 9, 1927, for the calendar year 1923.
The record of this case is most inadequate and unsatisfactory in regard to the essential facts upon which the plaintiff bases its contention; the facts are left in the twilight zone and the court is expected to pick out and piece together a case for the plaintiff from inferences and assumptions. All of the facts were well known to the officers of the old and new corporations and there is no assignment of any reason why the testimony of these officials has not been produced. From this vague record we gather that the plaintiff claims a capital set-up of approximately $200,000. In arriving at this amount plaintiff attempts to show that it purchased the entire assets of an insolvent corporation at a public sale held by the receiver of this corporation for the sum of $60,000; and that when this purchase was made it had an understanding with the agent of the creditors of this insolvent corporation whereby certain creditors' claims would be assumed by it. And as a matter of fact, in carrying out this agreement, the plaintiff subsequently paid the sum of $147,795.37 on the liabilities of the insolvent corporation although it only agreed to assume $137,735.98. There is no reason given for the additional payment. There is nothing in the record to show that the assets were worth more than the sum of $60,000 for which they were purchased at the public sale. The receiver who sold the assets was not a party to the agreement. The agent of the creditors made the so-called "agreement." The evidence fails to disclose if all, or what proportion, of the creditors were protected by the agreement and to what extent. There is an intimation in the record that the stockholders of the new corporation are the same as those of the old corporation; that these stockholders were the creditors of the old corporation; and that the new corporation was formed for the purpose of taking care of these creditor-stockholders. But there is no clear evidence to substantiate these facts. Who the creditors were whose claims were assumed and subsequently paid, is left in uncertainty.
The plaintiff contends that it is entitled to combine the actual cost of the assets at the receiver's sale and the liabilities under the agreement with the agent of the creditors so that its books will reflect the actual outlay of the two amounts and not solely the amount of the purchase price at the receiver's sale.
There is no question that the plaintiff would have been entitled to have included the debts assumed, if this assumption had been a part of the consideration of the purchase price at the receiver's sale. It would have then been a capital and not a business expense, as held in Athol Manufacturing Company v. Commissioner (C.C.A.) 54 F.2d 230, and as the Board of Tax Appeals has repeatedly held. Randolph Bergfeld, 19 B.T.A. 312, and Consolidated Coke Co., 25 B.T.A. 345. But the instant case is outside the rule laid down in these decisions. The agreement was no part of the purchase price of the assets of the old corporation.
The Commissioner of Internal Revenue made an audit of plaintiff's books for the purpose of ascertaining plaintiff's tax liability and decided $60,000 was the true capital expenditure, and on this amount assessed the tax. The rule is elementary that in tax proceedings a determination of the Commissioner is prima facie correct, and the burden is upon the plaintiff to overcome this presumption by the greater weight of the evidence. Wickwire v. Reinecke, 275 U.S. 101, 48 S. Ct. 43, 72 L. Ed. 184.
The evidence in this case fails to sustain the burden and, on the contrary, lends support to the Commissioner's decision. It is not necessary to discuss the other contentions of the plaintiff in detail. All of them are based on the capital set-up, and since we are clearly of the opinion that the amount found by the Commissioner should be affirmed, these contentions disappear from the case.
The petition should be dismissed. It is so ordered.