Opinion
Docket No. 27971.
1953-01-28
RADIO SHACK CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
George B. Lourie, Esq., and Arnold R. Cutler, Esq., for the petitioner. John B. King, Esq., and William J. Stetter, Esq., for the respondent.
George B. Lourie, Esq., and Arnold R. Cutler, Esq., for the petitioner. John B. King, Esq., and William J. Stetter, Esq., for the respondent.
Petitioner challenged as inadequate the relief accorded to it by the Commissioner by reason of certain changes in its business which qualified it for relief under section 722(b)(4), I.R.C. Constructive average base period net income determined.
The petitioner filed claims for relief from excess profits taxes, for the fiscal years ended June 30, 1941, through June 30, 1946, inclusive, under section 722(b)(4) of the Internal Revenue Code. The Commissioner granted relief to the extent of allowing a constructive average base period net income of $9,000 for the fiscal year ended June 30, 1941, and $12,000 for the remaining years. The petitioner appealed to this Court for a redetermination of the amount of relief to which it was entitled. It contends for a constructive average base period net income in an amount ‘not less than $24,500 to $26,972.‘
FINDINGS OF FACT.
The stipulation of facts filed by the parties is incorporated herein by reference.
The petitioner, Radio Shack Corporation (hereinafter also referred to as ‘Radio Shack‘), was organized as a corporation under the laws of the Commonwealth of Massachusetts on December 26, 1935, and began the business of selling radio and electronic parts on January 1, 1936. It acquired, as of that date, the business of a sole proprietorship which had been owned and operated by one Milton Deutschmann since 1933.
Since its organization, the petitioner has kept its books on the accrual method of accounting and through 1938 its accounting period was the calendar year. It filed a Federal income tax return for the 6-month period ended June 30, 1939; as of that date it changed its accounting period to a fiscal year ending June 30, and has subsequently maintained its books on that basis. The petitioner has filed, with the collector of internal revenue for the district of Massachusetts, timely corporation income tax, declared value excess profits tax and excess profits tax returns for the fiscal years ended June 30, 1941, through June 30, 1946, inclusive.
The business acquired by Radio Shack from Milton Deutschmann had been and continued to be conducted until September 1939, in a basement store of approximately 7,000 cubic feet at 46 Brattle Street, Boston, Massachusetts. That street was not a main thoroughfare; it was an old street with an assortment of small shops on it, including a barber shop, a tailor shop, and a few small radio establishments, such as petitioner's. The rental for petitioner's store was $50 per month through September 1936, and $65 per month thereafter until October 1, 1940, at which time the lease expired. In August 1938, petitioner entered into a lease, effective October 1, 1938, for the premises known as 167 Washington Street, Boston, for a monthly rental of $200. Possession of these premises, a street level store of approximately 52,000 cubic feet, was not obtained until September 1939. The Washington Street store, currently petitioner's office and principal place of business, is located on a main thoroughfare about 150 yards from the old Brattle Street location.
The business of Radio Shack as conducted at the Brattle Street store was substantially all cash sales, dependent upon a transient trade and a capacity to attract experimenters and amateurs in the electronics field. In 1938 and 1939, the petitioner took certain steps to bring about changes in the kind of business that had previously been conducted. The services of a catalogue expert were obtained, and in the fall of 1938 he came to Boston to publish a Radio Shack catalogue. This catalogue was intended to attract a mail order business and an industrial business, i.e., sales to schools, laboratories, and industry. In September 1938, 25,000 copies of the catalogue, postdated 1939 for use during that year, were published, and in 1939, 40,000 copies, postdated 1940, were published and distributed. At that time there were about 4 or 5 other concerns in the same business which prepared and distributed their own catalogues. In addition, two men were hired: a salesman to solicit industrial business and a credit manager to handle the accounts that were expected to develop. Petitioner's change in location, referred to above, was intended to provide additional space in which to stock larger inventories for the carrying on of the sought after mail order and industrial business as well as to increase the transient cash business. It was further anticipated by petitioner that with its new location and potential increase in its gross business, it would be enabled to purchase some of its merchandise as a ‘dealer‘ directly from the manufacturers at greater discounts than it was then receiving as a ‘sub-dealer.‘
The authorized capital stock of the petitioner consists of no-par value common stock and 6 per cent non-cumulative preferred stock having a par value of $100 per share and was issued as follows:
+-----------------------------------------------------------------------------+ ¦Common Stock (No-par Value) ¦ +-----------------------------------------------------------------------------¦ ¦ ¦Number¦ ¦ ¦ +---------+------+------------+-----------------------------------------------¦ ¦Date ¦of ¦Issued to ¦Consideration ¦ ¦issued ¦shares¦ ¦ ¦ +---------+------+------------+-----------------------------------------------¦ ¦Jan. 1, ¦100 ¦Milton ¦For all assets of sole proprietorship owned by ¦ ¦1936 ¦ ¦Deutschmann ¦Milton Deutschmann. 1 ¦ +---------+------+------------+-----------------------------------------------¦ ¦Dec. 30, ¦100 ¦Milton ¦$10,000 cash. ¦ ¦1938 ¦ ¦Deutschmann ¦ ¦ +---------+------+------------+-----------------------------------------------¦ ¦Apr. 16, ¦100 ¦Milton ¦$10,000 cash. ¦ ¦1941 ¦ ¦Deutschmann ¦ ¦ +---------+------+------------+-----------------------------------------------¦ ¦July 10, ¦100 ¦Milton ¦$10,000 cash. ¦ ¦1941 ¦ ¦Deutschmann ¦ ¦ +---------+------+------------+-----------------------------------------------¦ ¦Dec. 30, ¦75 ¦Milton ¦$7,500 cash. ¦ ¦1941 ¦ ¦Deutschmann ¦ ¦ +---------+------+------------+-----------------------------------------------¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
Preferred Stock (Par Value $100 Per Share) Number Date issued of shares Issued to Consideration June 30, 1942 150 Milton Deutschmann $15,000 cash. June 30, 1942 70 Arnold Deutschmann $7,000 cash. June 30, 1942 50 Theodore Deutschmann $5,000 cash. June 30, 1942 50 A. L. Deutschmann $5,000 cash. July 30, 1943 20 Alfred Kaplan $2,000 cash.
Petitioner's actual monthly sales for its base period were as follows:
+-----------------------------------------------------------------------+ ¦ ¦1936 ¦1937 ¦1938 ¦1939 ¦1940 ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦January ¦ ¦$8,073.70¦$7,363.36 ¦$10,132.48¦$14,151.01 ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦February ¦ ¦6,990.22 ¦7,992.96 ¦13,061.08 ¦14,243.84 ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦March ¦ ¦9,158.17 ¦8,669.17 ¦12,569.74 ¦15,899.41 ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦April ¦ ¦7,323.45 ¦6,330.89 ¦9,849.14 ¦12,019.86 ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦May ¦ ¦6,790.40 ¦7,006.86 ¦10,062.72 ¦12,808.45 ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦June ¦ ¦6,730.25 ¦7,580.08 ¦6,818.21 ¦12,860.45 ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦6-month total¦ ¦45,066.19¦44,943.32 ¦62,493.37 ¦81,983.02 ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦July ¦ ¦6,884.90 ¦5,933.86 ¦7,623.47 ¦ ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦August ¦ ¦7,535.56 ¦8,364.09 ¦10,171.43 ¦ ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦September ¦ ¦9,307.11 ¦8,632.54 ¦9,824.51 ¦ ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦October ¦ ¦8,785.13 ¦11,046.55 ¦12,651.05 ¦ ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦November ¦ ¦8,997.20 ¦12,052.69 ¦13,586.29 ¦ ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦December ¦ ¦8,919.23 ¦16,158.13 ¦15,880.60 ¦ ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦6-month total¦ ¦50,429.13¦62,187.86 ¦69,737.35 ¦ ¦ +-------------+----------+---------+----------+----------+--------------¦ ¦Annual total ¦$75,672.55¦95,495.32¦107,130.68¦132,230.72¦2 151,720.37¦ +-------------+----------+---------+----------+----------+--------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------+
Petitioner's excess profits net income for each of the base period years is as follows:
+---------------------------------------------------------+ ¦Base period year ¦Fiscal year¦Fiscal years ¦ +------------------------------+-----------+--------------¦ ¦ ¦6/30/41 1 ¦6/30/42-46 2 ¦ +------------------------------+-----------+--------------¦ ¦1936 ¦$118.37 ¦$138.33 ¦ +------------------------------+-----------+--------------¦ ¦1937 ¦475.70 ¦555.97 ¦ +------------------------------+-----------+--------------¦ ¦1938 ¦410.17 ¦468.77 ¦ +------------------------------+-----------+--------------¦ ¦Period Jan. 1 to June 30, 1939¦607.07 ¦693.80 ¦ +------------------------------+-----------+--------------¦ ¦Fiscal year June 30, 1940 ¦1,278.50 ¦1,461.14 ¦ +------------------------------+-----------+--------------¦ ¦ ¦ ¦ ¦ +---------------------------------------------------------+ Computed under the Revenue Act of 1940.Computed under the Revenue Acts of 1941 and 1942, as applicable.
Surely, taking such facts into account flies in the face of the explicit injunction in section 722(a) that in determining the constructive average base period net income ‘no regard shall be had to events or conditions affecting the taxpayer * * * occurring or existing after December 31, 1939 * * * .‘
Moreover, the situation as it existed in the years 1947-1949 may well have depended upon economic or other conditions prevailing in those years. We have no reason whatever to assume that a similar relationship between petitioner's various classes of business would have been the norm in the base period. And finally, the 1947-1949 situation reflects not 2 years of additional experience, as contemplated by section 722(b)(4), but rather some 8 to 10 years of development.
Petitioner also proposed to support a reconstruction of its earnings by comparison with the Boston branch store of another company, Wholesale Radio Service Co., Inc., known as ‘Lafayette Radio.‘ However, that store did no mail order or industrial business, such business being handled by the main store in New York. Petitioner attempted to equate the operations of Lafayette Radio with its own by allocating arbitrarily additional sales of $100,000 for mail order and industrial business to the Boston operations of Lafayette Radio, and it assumed that the net profit on the composite of all such operations would be 7 per cent of its gross income. To be sure, there was testimony by a former employee of Lafayette Radio, based on his experience with that organization, that 7 per cent of gross income was a normal net profit for that type of business in 1939. But there is grave doubt on this record whether such ratio would have been the same for Radio Shack. The Lafayette store was part of a national organization whose buying power and management may well have placed it in a position superior to that of petitioner. Furthermore, the 7 per cent figure must be contrasted with Radio Shack's actual net profits for its last base period year, which were less than 1 per cent of its gross sales.
It is true that in determining relief under section 722, a reconstruction must be based to some extent on hypothesis and conjecture. The nature of the problem requires the use of some imagination and practical judgment. But there must be facts upon the basis of which such judgment can be exercised. And it is our conclusion that petitioner has not established a sufficiently acceptable foundation for the reconstructions that it asks this Court to approve.
On the other hand, we are satisfied on the record as a whole that the relief granted by the respondent is inadequate. Using our best judgment on the entire record, we have found as a fact and conclude that petitioner's constructive average base period net income is $15,000 for each of the years involved, except the fiscal year ended June 30, 1941, which is involved herein only for the purpose of carry-over, and for which we have determined a constructive average base period net income of $11,000. The fiscal year ended June 30, 1941, did not represent a full year's operations at the level that petitioner would have attained had it made its changes 2 years earlier. Accordingly, in granting relief the Commissioner applied the so-called variable credit rule (Regulations 112, section 35.722-3(d), as amplified by Bulletin on Section 722, pp. 120-123). Upon the facts here presented we are satisfied that this is an appropriate case for the application of the variable credit rule. Petitioner's principal contention in this regard is that the variable credit rule is invalid. However, the validity of the regulations has been sustained in Nielsen Lithographing Co., 19 T.C. 605, and that decision is controlling in this case. Applying the variable credit rule here we have found that the constructive average base period net income for the fiscal year ended June 30, 1941, is $11,000.
Reviewed by the Special Division.
Decision will be entered under Rule 50. 1.Petitioner asserts that Deutschmann's opinion was a contemporaneous estimate and that reference to the years 1947-1949 was merely for confirmation. We are not convinced that such is the fact; and we are satisfied, on the basis of the testimony which we heard, that Deutschmann's estimate was predicated largely upon the 1947-1949 experience. 2.The proposed reconstruction contained in petitioner's applications for relief (Form 991) for the fiscal years ended June 30, 1941, 1942, and 1943 was based to a large extent on other post-1939 data and is therefore equally unacceptable under section 722(a) of the Code. The proposed reconstruction in the applications for relief for the remaining fiscal years, ending in 1944, 1945, 1946, was abandoned by petitioner in its brief. -------- Notes:
1Such assets had a declared value of $10,000.
1Monthly sales not available for year 1936.2Represents total sales for fiscal year July 1, 1939, to June 30, 1940.
Petitioner's excess profits net income for each of the fiscal years material to this proceeding is as follows:
+--------------------------------------+ ¦Fiscal year ended June 30 ¦Amount ¦ +---------------------------+----------¦ ¦1940 (Under 1940 Act) ¦$7,233.52 ¦ +---------------------------+----------¦ ¦1941 (Under 1941 Act) * ¦8,671.92 ¦ +---------------------------+----------¦ ¦1942 ¦45,898.14 ¦ +---------------------------+----------¦ ¦1943 ¦221,284.55¦ +---------------------------+----------¦ ¦1944 ¦165,962.81¦ +---------------------------+----------¦ ¦1945 ¦72,544.13 ¦ +---------------------------+----------¦ ¦1946 ¦43,869.54 ¦ +---------------------------+----------¦ ¦ ¦ ¦ +--------------------------------------+ FN* For carry-over purposes only under section 710 (c), Internal Revenue Code.
Since the petitioner was in existence during the base period years, it is entitled to compute its excess profits credit under the provisions of section 713 of the Internal Revenue Code. However, since petitioner's excess profits credit computed on the invested capital basis pursuant to section 714 of the Internal Revenue Code resulted in a lesser excess profits tax prior to the application of section 722 of the Internal Revenue Code, such method was used by petitioner when it filed its excess profits tax returns for the fiscal years 1941 through 1946.
Petitioner's excess profits credit computed under the invested capital method of section 714 of the Internal Revenue Code for each of the fiscal years material to this proceeding is as follows:
+----------------------------------------------+ ¦Year ended June 30 ¦Invested capital credit ¦ +--------------------+-------------------------¦ ¦1941 ¦$1,965.27 ¦ +--------------------+-------------------------¦ ¦1942 ¦4,623.68 ¦ +--------------------+-------------------------¦ ¦1943 ¦10,067.91 ¦ +--------------------+-------------------------¦ ¦1944 ¦12,672.82 ¦ +--------------------+-------------------------¦ ¦1945 ¦15,358.49 ¦ +--------------------+-------------------------¦ ¦1946 ¦17,779.43 ¦ +----------------------------------------------+
The petitioner filed timely applications for relief (Form 991) under section 722 of the Internal Revenue Code for the fiscal years ended June 30, 1941, through June 30, 1946, inclusive.
The respondent determined that the petitioner was entitled to a constructive average base period net income under section 722 of the Internal Revenue Code in the amount of $9,000 for the fiscal year ended June 30, 1941, and in the amount of $12,000 for each of the fiscal years ended June 30, 1942, 1943, 1944, 1945, and 1946.
The constructive average base period net income of $9,000, which was granted for the fiscal year ended June 30, 1941, was determined primarily for unused excess profits credit carry-over purposes and such constructive average base period net income for the fiscal year ended June 30, 1941, is after the application of the so-called variable credit rule set forth in Regulations 112, section 35.722-3(d).
The benefits received by the petitioner under section 710(a)(1)(B) of the Internal Revenue Code exceed those allowed by the respondent under section 722 of the Internal Revenue Code for the fiscal year ended June 30, 1943.
Petitioner's excess profits tax liability reflecting the partial allowance by the Commissioner of petitioner's claims for relief under section 722 of the Internal Revenue Code, for each of the fiscal years material to this proceeding, is as follows:
+--------------------------------------+ ¦Fiscal year ended June 30 ¦Amount ¦ +---------------------------+----------¦ ¦1941 ¦None ¦ +---------------------------+----------¦ ¦1942 ¦$10,350.32¦ +---------------------------+----------¦ ¦1943 ¦173,059.30¦ +---------------------------+----------¦ ¦1944 ¦127,408.88¦ +---------------------------+----------¦ ¦1945 ¦40,343.72 ¦ +---------------------------+----------¦ ¦1946 ¦6,960.96 ¦ +--------------------------------------+
During the base period the petitioner changed the character of its business so as to qualify for relief under section 722(b)(4), I.R.C., by changing location and increasing the size of its store, commencing and attempting to develop a mail order and industrial business. The business of the petitioner did not reach by the end of the base period the earning level which it would have reached if the petitioner had made its changes 2 years earlier. Petitioner's constructive average base period net income is $15,000 for each of the years involved, except the fiscal year ended June 30, 1941, which did not represent a full year's operations at the level that petitioner would have attained had it made its changes 2 years earlier, and for which petitioner's constructive average base period net income is $11,000.
OPINION.
RAUM, Judge:
It is admitted by the Commissioner that the petitioner qualifies for relief under section 722(b)(4) of the Code and is therefore entitled to reconstruct its average base period net income so as to reflect more clearly its normal earnings. The Commissioner has allowed a constructive average base period net income in the amount of $9,000 for the fiscal year ended June 30, 1941, and $12,000 for the fiscal years ended June 30, 1942, 1943, 1944, 1945, and 1946. Petitioner contends that this is inadequate and has appealed to this Court.
Petitioner has undertaken to establish by several reconstructions that its constructive average base period net income is an amount ‘not less than $24,500 to $26,972.‘ However, we are enable to accept these reconstructions. Petitioner's accountant, who was its main witness in this connection, plainly relied in large part upon facts that he was not entitled to take into account or upon unsupported assumptions.
According to the evidence, petitioner's mail order and industrial business did not appear to be more than a relatively small portion of its total business at the end of 1939. But the basic assumption of the accountant's principal reconstructions was that if the qualifying changes had taken place 2 years earlier, petitioner's mail order and industrial business would have increased to such an extent as to constitute 60 per cent of its total business by the end of 1939. Accordingly, after making certain other adjustments and computations with respect to petitioner's actual base period earnings (which he treated as being allocable solely to its cash business), he increased those earnings by 150 per cent, so that such earnings prior to the increase would constitute 40 per cent of the new figure. The remaining 60 per cent of the new figure he treated as being allocable to the mail order and industrial business, which he assumed would have attained such magnitude had it been started 2 years earlier.
However, the difficulty with the foregoing assumption is that there is no reliable or competent evidence in the record before us to support it. True, Milton Deutschmann testified that such, in his opinion, would have been the growth of the mail order and industrial business. But we are satisfied that such testimony was merely an extravagant guess that was not founded on any facts that could properly be taken into account. Indeed, his testimony strongly suggests to us that he based it primarily upon the actual relationship between petitioner's cash business and its mail order and industrial business as of the years 1947, 1948, and 1949.