Opinion
Docket Nos. 8776 31172 31173.
1951-12-29
THE LAMPORT COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Harold Wisan, Esq., for the petitioner. Aaron S. Resnik, Esq., for the respondent.
1. EXCESS PROFITS TAX— ACQUIRING CORPORATION— QUALIFIED COMPONENT CORPORATION— SECTION 740.— The taxpayer corporation's acquisition of all of the property of another corporation, that was in existence at the beginning of the base period, in exchange for all of its outstanding stock constitutes it an acquiring corporation and the other a qualified component corporation within the meaning of section 740.
2. EXCESS PROFITS TAX— RELIEF UNDER SECTION 722— CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.— The taxpayer is denied relief under section 722 regardless of whether or not it qualifies for relief under that section because the evidence does not indicate that a credit based upon constructive average base period net income would exceed the large credit to which the taxpayer is entitled under the invested capital method. Harold Wisan, Esq., for the petitioner. Aaron S. Resnik, Esq., for the respondent.
The Commissioner denied applications for relief under section 722 for the years 1941 through 1945. The only issue for decision is whether the petitioner is entitled to relief for those years under section 722(b)(2), (3), and (4).
FINDINGS OF FACT.
The petitioner, which alone filed the petitions, was incorporated under the laws of the State of New York in 1941. It issued its debentures and all of its outstanding stock and assumed all of the liabilities of a predecessor corporation at the end of 1941 in exchange for all of the properties of that predecessor. It is an acquiring corporation and the predecessor is a qualified component corporation within the meaning of section 740 of the Internal Revenue Code. The predecessor had been organized in 1919. Its name was the same as that of the petitioner. It was the taxpayer during 1941. It liquidated and dissolved shortly after transferring its business. Hereafter, for convenience, both corporations will be referred to at times as the petitioner. The books were kept and the returns were filed on a calendar year basis.
The petitioner, at all times material to these proceedings, was engaged in the business of buying and selling textiles at wholesale, dealing almost exclusively in cotton goods. Approximately 90 per cent of the merchandise which it handled consisted of off-standard goods, that is, goods which differ in width, length, or pattern from the specifications agreed to by a mill or bleachery. The petitioner was the only company of comparable size in the New York area which dealt almost exclusively in off-standard goods.
The petitioner obtained its materials under annual contracts which required it to accept all off-standard goods produced by the other party during the contract year. Those contracts were subject to quarterly adjustments in order to compensate for the rise or fall of cotton prices. They were difficult to obtain and, once cancelled, difficult to renew.
Department 15 was established by the petitioner in 1932. Goods were purchased for that department by the pound and sold to customers by the yard. Some of the goods were arranged into unsorted bundles according to yardage. Other materials were measured and then left in the shipping cases in which they had been received. Goods were generally sold in unsorted case lots and customers were forced to accept the entire contents of a case regardless of the fact that it might contain a large quantity of undesired items. Customers became dissatisfied with the system and began to exert pressure on the petitioner to package its goods in related and uniform assortments of readily salable goods. The petitioner started experimenting with a selected package after 1932, but the space necessary for making such a package for commercial distribution was unavailable in the New York plant. The petitioner began searching in 1936 for a plant in which it could have the necessary facilities and such a plant was acquired in August 1937 at Fall River, Massachusetts. The acquisition of the Fall River Plant was also motivated by labor difficulties in New York and the desire to acquire a plant permitting a more rapid turnover of goods.
Shortly after the acquisition of the new plant, the petitioner started to assemble a line of bundles or packages which offered customers a standardized assortment of first quality fabrics of similar construction, color, and pattern. Goods were obtained as formerly, but were culled, cleaned, and sorted, and then packaged according to a uniform system. The new line consisted of different types of bundles each bearing a name by which it could be reordered. All bundles with the same name contained goods similar in size, color, and type of fabric. Customers were able to obtain a wider variety of quality fabrics for a smaller investment than would have been possible by purchasing directly from the manufacturers. The bundles were attractive to the eye and could be displayed on customers' counters. They were made to meet the needs of individual customers and consisted of fabrics salable in the community of the particular customer. Customers were no longer forced to purchase unsorted case lots and to accept unwanted goods. The bundle produced by the petitioner at its Fall River plant was a new and different product.
This new product appeared on the market in 1938 and was an immediate success. The bundles were approximately as good when first introduced as they were 2 years later, although some additional experimentation was necessary in order to perfect the new line. The petitioner charged higher prices for the new bundles although the increased cost of processing was relatively small. A relatively large stock of materials had to be on hand in order to furnish the proper ingredients for the new bundle. There was demand for more packages than the petitioner supplied
The gross sales and gross profits of Department 15 for the years 1933 through 1940 were as follows:
+-------------------------------------------------+ ¦Year ¦Sales ¦Gross profit ¦ +----------------------+------------+-------------¦ ¦1933 ¦$712,855.97 ¦$70,020.13 ¦ +----------------------+------------+-------------¦ ¦1934 ¦1,063,007.21¦128,053.28 ¦ +----------------------+------------+-------------¦ ¦1935 ¦978,039.70 ¦121,465.92 ¦ +----------------------+------------+-------------¦ ¦1936 ¦1,262,780.82¦Not available¦ +----------------------+------------+-------------¦ ¦1937 ¦1,176,498.13¦Do. ¦ +----------------------+------------+-------------¦ ¦1936 and 1937 combined¦ ¦267,956.37 ¦ +----------------------+------------+-------------¦ ¦1938 ¦1,730,318.17¦Not available¦ +----------------------+------------+-------------¦ ¦1939 ¦1,550,521.63¦119,437.88 ¦ +----------------------+------------+-------------¦ ¦1940 ¦1,372,261.54¦85,605.92 ¦ +-------------------------------------------------+
The petitioner financed a large part of its operations by borrowing substantial amounts from banks. One of its principal creditors, the Chase National Bank, withdrew its line of credit in August 1938. That action was taken because the bank believed that the petitioner was unnecessarily maintaining excessive inventories and carrying too large a debt. The bank also disapproved of withdrawals by corporate officers over and above their salaries and of the petitioner's tendency to invest in companies not akin to its business. The other banks from which the petitioner had borrowed money began to insist that it pay off or materially reduce its indebtedness. They exerted pressure on the petitioner to reduce its inventories and to turn them over more rapidly. They were likewise critical of the policies and practices of the petitioner which caused the Chase National Bank to withdraw its line of credit.
The petitioner's total unsecured indebtedness to banks as of December 31 of the years 1936 through 1941 was as follows:
+-----------------------------------+ ¦Year¦Chase ¦All others¦Total ¦ +----+--------+----------+----------¦ ¦1936¦$300,000¦$800,000 ¦$1,100,000¦ +----+--------+----------+----------¦ ¦1937¦450,000 ¦1,150,000 ¦1,600,000 ¦ +----+--------+----------+----------¦ ¦1938¦ ¦1,250,000 ¦1,250,000 ¦ +----+--------+----------+----------¦ ¦1939¦ ¦600,000 ¦600,000 ¦ +----+--------+----------+----------¦ ¦1940¦ ¦500,000 ¦500,000 ¦ +----+--------+----------+----------¦ ¦1941¦ ¦ ¦ ¦ +-----------------------------------+
A life insurance loan which was obtained in May 1939 in the amount of $315,000 was still outstanding at the end of the base period.
The petitioner's credit rating with Dun and Bradstreet was lowered slightly in September 1939 as a result of declines in its net worth and working capital and its unbalanced condition characterized by heavy inventories and large liabilities.
The petitioner invested, during the base period, in securities of both its suppliers and its customers as a means of promoting good will and retaining contracts. Those investments and others as of December 31 of each of the base period years amounted to approximately $465,000. Loans outstanding to officers amounted to about $624,000 at the end of 1936 and increased during the base period to approximately $694,000.
An index of the wholesale prices of cotton goods, middling cotton, and of all commodities during the years 1920 through 1940, with 1926 as ‘100,‘ is as follows:
+---------------------------------+ ¦Year¦Cotton¦Middling¦All ¦ +----+------+--------+------------¦ ¦ ¦goods ¦cotton ¦commodities ¦ +----+------+--------+------------¦ ¦1920¦190.7 ¦193.3 ¦154.4 ¦ +----+------+--------+------------¦ ¦1921¦99.5 ¦86.3 ¦97.6 ¦ +----+------+--------+------------¦ ¦1922¦104.3 ¦121.0 ¦96.7 ¦ +----+------+--------+------------¦ ¦1923¦116.9 ¦167.0 ¦100.6 ¦ +----+------+--------+------------¦ ¦1924¦114.7 ¦163.9 ¦98.1 ¦ +----+------+--------+------------¦ ¦1925¦110.0 ¦133.8 ¦103.5 ¦ +----+------+--------+------------¦ ¦1926¦100.0 ¦100.0 ¦100.0 ¦ +----+------+--------+------------¦ ¦1927¦97.1 ¦100.2 ¦95.4 ¦ +----+------+--------+------------¦ ¦1928¦100.4 ¦114.1 ¦96.7 ¦ +----+------+--------+------------¦ ¦1929¦98.8 ¦109.0 ¦95.3 ¦ +----+------+--------+------------¦ ¦1930¦84.7 ¦77.1 ¦86.4 ¦ +----+------+--------+------------¦ ¦1931¦66.1 ¦48.7 ¦73.0 ¦ +----+------+--------+------------¦ ¦1932¦54.0 ¦36.6 ¦64.8 ¦ +----+------+--------+------------¦ ¦1933¦71.2 ¦49.5 ¦65.9 ¦ +----+------+--------+------------¦ ¦1934¦86.5 ¦70.4 ¦74.9 ¦ +----+------+--------+------------¦ ¦1935¦83.4 ¦67.8 ¦80.0 ¦ +----+------+--------+------------¦ ¦1936¦80.3 ¦69.1 ¦80.8 ¦ +----+------+--------+------------¦ ¦1937¦84.3 ¦65.3 ¦86.3 ¦ +----+------+--------+------------¦ ¦1938¦65.4 ¦49.3 ¦78.6 ¦ +----+------+--------+------------¦ ¦1939¦67.2 ¦53.9 ¦79.1 ¦ +----+------+--------+------------¦ ¦1940¦71.4 ¦59.3 ¦78.6 ¦ +---------------------------------+
The average of net sales of the petitioner during the base period was about the same as the average for the preceding 10-year period, but its gross profits were low during that period as compared to those of the preceding 10-year period.
The petitioner's excess profits net income for the years 1920 through 1939 was as follows:
+-----------------------------------------------+ ¦ ¦Excess profits ¦ ¦Excess profits ¦ +------+----------------+------+----------------¦ ¦Year ¦net income ¦Year ¦net income ¦ +------+----------------+------+----------------¦ ¦1920 ¦$8,344.43 ¦1930 ¦($132,200.25) ¦ +------+----------------+------+----------------¦ ¦1921 ¦206,819.74 ¦1931 ¦(181,318.25) ¦ +------+----------------+------+----------------¦ ¦1922 ¦876,504.41 ¦1932 ¦(188,474.83) ¦ +------+----------------+------+----------------¦ ¦1923 ¦561,635.41 ¦1933 ¦402,930.03 ¦ +------+----------------+------+----------------¦ ¦1924 ¦276,988.53 ¦1934 ¦53,983.93 ¦ +------+----------------+------+----------------¦ ¦1925 ¦39,533.73 ¦1935 ¦127,821.58 ¦ +------+----------------+------+----------------¦ ¦1926 ¦(8,791.38) ¦1936 ¦(2.059.01) ¦ +------+----------------+------+----------------¦ ¦1927 ¦140,354.20 ¦1937 ¦(63,360.91) ¦ +------+----------------+------+----------------¦ ¦1928 ¦218,262.60 ¦1938 ¦(87,192.14) ¦ +------+----------------+------+----------------¦ ¦1929 ¦83,205.78 ¦1939 ¦(62,877.39) ¦ +-----------------------------------------------+
The petitioner computed its excess profits credit for each of the years 1941 through 1945 on the invested capital method. Its credit computed under that method for each of those years is as follows:
+------------------------+ ¦ ¦Excess profits ¦ +------+-----------------¦ ¦Year ¦credit ¦ +------+-----------------¦ ¦1941 ¦( $241,154.89 ¦ +------+-----------------¦ ¦ ¦(1 200,524.71 ¦ +------+-----------------¦ ¦1942 ¦163,765.50 ¦ +------+-----------------¦ ¦1943 ¦121,924.07 ¦ +------+-----------------¦ ¦1944 ¦108,243.37 ¦ +------+-----------------¦ ¦1945 ¦123,095.96 ¦ +------------------------+ FN1 Carry-over from 1940.
Applications for relief under section 722(b)(1), (2), (3), (4), and (5) and claims for refund based thereon for the years 1941 through 1945 were duly filed by the petitioner and denied by the respondent.
The stipulations of the parties and the exhibits attached thereto are incorporated herein by this reference.
OPINION.
MURDOCK, Judge:
The petitioner acquired all of the properties of the predecessor corporation, and a part of the consideration for the transfer of those properties was the transfer to the predecessor of all of the outstanding stock of the petitioner. The petitioner thus qualifies as an acquiring corporation and the predecessor as a qualified component corporation under section 740(a)(1)(A) and (b)(1) for whatever benefit the taxpayer may derive therefrom under section 722(e)(2). The predecessor was the taxpayer for 1941 but it has not filed a petition with the Court.
The petitioner mentioned all of the five sub-paragraphs of section 722(b) in its applications for relief but now does not press any claims under sub-paragraphs (1) and (5). Its claim under (2) is that its business was depressed during the base period by unusually low cotton prices and by an unusual reduction of its bank credits. It contends, as an alternative to the above claim, that its business was depressed within the meaning of section 722(b)(3)(B) ‘by reason of conditions generally prevailing in its industry resulting in the base period inadequately representing its periods of normal or high profits.‘ The remaining contention of the petitioner is that it changed the character of its business during the base period within the meaning of section 722(b)(4) by the introduction in 1938 of a new product, the Fall River Bundle. These contentions all go to the question of whether the petitioner qualifies for relief under one or more of the provisions of section 722(b).
The business of the petitioner was depressed in the base period, although much less so than it was during the years 1930 through 1932. The petitioner has failed to show the extent, if any, to which the base period depression was due to the decline in cotton prices or that that decline was temporary. The losses might have been due to other factors. Cf. Trunz, Inc., 15 T.C. 99, 104. The banks restricted the credit of the petitioner primarily because of their objections to business policies practiced by the petitioner, not because of unusual economic conditions over which the taxpayer had no control. Consequently, the restriction can not be regarded as a temporary economic circumstance within the meaning of section 722(b)(2). Cf. Foskett & Bishop Co., 16 T.C. 456; Avey Drilling Machine Co., 16 T.C. 1281. The record is not clear as to the extent of the effect of the restricted credit on the business of the petitioner. Any change in the business due to the introduction of the Fall River Bundle was not reflected in an increased level of normal earnings directly attributable to the change. Cf. Wisconsin Farmer Co., 14 T.C. 1021; Roy Campbell, Wise & Wright, Inc., 15 T.C. 894. Regulations 112, section 35.722-3(d). The record leaves the Court in serious doubt as to any possible benefit from the ‘push-back rule.‘ The extent to which the restricted bank credit affected this new product is not clear. The alternative contention of the petitioner is argued superficially and is not borne out by the evidence. However, this record would not justify the granting of any relief even if the petitioner clearly qualified for relief as it claims, under two of the subparagraphs of section 722(b), i.e., even if the base period depression was due in part to low cotton prices and to the credit restriction and the Fall River Bundle was a profitable change.
The excess profits net income of the petitioner for each of the four base period years, after drastic salary reductions, was a minus quantity, the average of which was $53,872.36. The plus average for the ten preceding years was $51,577.34. The petitioner would go back further to disclose more favorable figures. Its excess profits tax credits were computed on the basis of invested capital. Those credits ranged from a low of about $108,000 in 1944 to a high of about $241,000 in 1941 for which year it also had a carry-over from 1940 of about $200,000. Obviously, the petitioner will not receive relief for any year under section 722 unless it can show a sufficient amount of constructive average base period net income to produce a credit in excess of the large credits which it has received under the invested capital method. Its proposed reconstruction is not supported by adequate evidence. Its record of past earnings and prospects of future earnings, as shown by this record, do not indicate that it is entitled to constructive average base period net income anywhere near sufficient to give it relief under the claims now made.
Reviewed by the Special Division.
Decision will be entered for the respondent.