24 T.C. 533 (1955), 25647, Smith's Heating, Inc. v. C.I.R.

Docket Nº:25647.
Citation:24 T.C. 533
Opinion Judge:HARRON, Judge:
Attorney:Jules G. Korner, 3rd, Esq., and A. T. Allen, C.P.A., for the petitioner. George LeBlanc, Esq., and Edward E. Pigg, Esq., for the respondent.
Case Date:June 29, 1955
Court:United States Tax Court

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24 T.C. 533 (1955)




No. 25647.

United States Tax Court.

June 29, 1955

Jules G. Korner, 3rd, Esq., and A. T. Allen, C.P.A., for the petitioner.

George LeBlanc, Esq., and Edward E. Pigg, Esq., for the respondent.

SEC. 722(c), 1939 CODE.- PETITIONER failed to establish a fair and just amount representing normal earnings if petitioner had been in business during the base period years; relief denied.

This proceeding involves the respondent's disallowance of petitioner's application for excess profits tax relief under section 722(c)(1) and (3), Internal Revenue Code of 1939, and the related claim for refund of excess profits tax in the amount of $29,157.99 for the calendar year 1945. In his notice of disallowance for the year 1945, respondent determined an excess profits tax liability of $45,691.31 and a deficiency of $14,361.34, the payment of which was deferred under Code section 710(a)(5). The amounts and dates of petitioner's payments of excess profits taxes for 1945 are stipulated.

The primary questions presented are whether petitioner qualified for relief under 1939 Code section 722(c)(1) and (3) by virtue of having intangible assets making important contributions to income but not

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includible in invested capital and further by virtue of having abnormally low invested capital and, if so qualified, the amount of its constructive average base period net income. A further question raised at the hearing, and if petitioner is granted relief herein, is whether petitioner is entitled to any carry-overs of unused excess profits credit from the years 1943 and 1944 to the year 1945.

The proceeding was heard before a commissioner designated by the Court for that purpose. The facts found in the commissioner's report are included herein as our Findings of Fact, with such modifications as are deemed necessary upon a consideration of the objections filed by the parties.


The stipulated facts are so found and included herein by reference.

The petitioner is a North Carolina corporation, organized November 8, 1940, with its principal office at Kinston, North Carolina. Petitioner kept its books and filed its tax returns on the calendar year accrual basis of accounting, and its returns for the years involved were filed with the collector of internal revenue for the district of North Carolina.

The petitioner filed a timely application for relief (Form 991) under section 722 of the 1939 Code and a related claim for refund (Form 843) of excess profits tax for the calendar year 1945 in the amount of $29,157.99. In connection therewith, and prior to the hearing in this proceeding, petitioner made no claim for carry-overs of unused excess profits credit from the years 1943 or 1944 to the year 1945.

The respondent disallowed petitioner's claims for relief and refund and determined that its excess profits credit for the year 1945 amounted to $365.20, computed on the invested capital basis of 8 per cent of total capital of $4,564.99 comprised of $200 money paid in and $4,364.99 earned surplus. Petitioner's 1945 return reported an excess profits net income of $66,833.40. The respondent applied the provisions of the 80 per cent limitation in his computation of petitioner's excess profits tax liability in the amount of $45,691.31 for the year 1945.

Since its organization in 1940, petitioner has engaged in the business of manufacturing, for sale to farmers, certain patented oil-burning tobacco curers which had been theretofore produced and sold by a prior existing corporation. Petitioner's outstanding capital stock consists of 129 shares (par value $100 each) of common stock of which 127 shares were issued to Forrest H. Smith, president of petitioner, 1 share to his wife Margaret for $100 cash, and 1 share to his son John for $100 cash. The 127 shares issued to Forrest H. Smith were in exchange for an exclusive 5-year license under United States Letters Patent No. 1,811,980 issued to Smith in 1930, and No. 2,051,348 issued to Smith in 1935, and also a pending patent application serial No.

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221,288 filed July 26, 1938. The parties are agreed that for excess profits tax purposes no amount was includible in petitioner's invested capital on account of the patent license.

During the years 1935 through 1939 similar oil-burning tobacco curers were manufactured and sold to farmers by Smith's Heating System, Inc., as the exclusive licensee under the above-mentioned patents. That corporation, of which Smith had been the majority stockholder and president, was declared bankrupt and was dissolved in 1940. Petitioner is not an acquiring corporation of Smith's Heating System, Inc., within the meaning of section 740, Internal Revenue Code.

Flue-cured tobacco is grown principally in the eastern section of North and South Carolina, and to a lesser extent in Virginia, Georgia, Alabama, and Florida. In those areas the ripened tobacco is harvested by being primed, which means that each leaf is plucked separately when ripe. The leaves are then taken to the tobacco barn for the curing process which consists of being allowed to wilt slightly, and then being subjected to a certain degree of even heat to drive out the excess sap and moisture. The traditional method of curing flue-cured tobacco was to heat the barns with wood-burning furnaces fired from outside the barn. From the furnace metal flues extended around the inside walls to the rear of the barn and returned along the center of the barn to give an even distribution of heat. The flues were vented through the walls or roof of the barn. The hand-fed wood-burning furnaces required the attendance of a worker, 24 hours a day, for 6 or 7 days a week during the curing season, to feed the fire every hour or two and to maintain a proper temperature inside the barn. In a good crop season approximately 2 1/2 to 3 acres of tobacco could be cured in the average size barn. Flue-curing tobacco barns vary in size from 15 to 18 feet square and 14 feet high. In eastern North Carolina the curing season begins around the first part of July and lasts from 4 to 6 weeks.

The Smith tobacco curer consists of a series of small open-flame oil burners, covered by protective metal canopies, arranged evenly over the floor of the tobacco barn so as to give an even distribution of heat. The burners are fed through pipes from an oil tank located outside the barn and the flow of oil is regulated by a carburetor. There are also individual controls on each burner. The size of the curer, that is, the number of burners installed in a particular tobacco barn, depends upon the size of the barn, but the average tobacco barn requires about 24 burners, more or less. At all times material here, the most widely used Smith tobacco curer was the Model A, consisting of numerous individual burners, each having a separate hood or canopy.

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The Smith Model D consists of a number of burners grouped under a single canopy, but comparatively few were ever sold.

Prior to obtaining his first patent, Smith had observed various types of furnaces and burners used in curing tobacco, in the course of his travels for the Florence Stove Company. The practice of using open-flame oil burners to heat and circulate the air in tobacco barns had been public knowledge for some years, and the use of multiple heating units was not a new idea. At least two makes of oil-burner tobacco curers were being made and sold at the time Smith developed his oil-burner curer which was designed for simple operation and maintenance, and for positive control of the desired uniform temperature in the barn. During the yearly 1930's, the oil-burning curers had not been adopted by farmers for general use in the flue-cured tobacco sections of North and South Carolina, and the predominant method then used was the traditional wood-burning furnace with metal flues.

Smith's Heating System, Inc. (sometimes hereinafter referred to as the old company), was organized in 1934 with a capitalization of $25,000 represented by 250 shares of $100 par value stock. Forrest H. Smith and his nominees, hie wife and sister-in-law, owned 129 shares which were issued in exchange for a license under Smith's tobacco curer patents. The license ran for the life of the patents. The remaining 121 shares were issued to three other persons for cash paid in. Smith was president of the company.

During the first year of its existence, the old company manufactured and sold 4 curers in 1934, 135 curers in 1935, and 472 in 1936, and in connection with making deliveries crews of men were sent out to superintend the installations and instruct the farmers in their use. Such service increased the company's operating costs, but insured proper operation and satisfactory results. By 1936, the Smith curer had acquired a good reputation for efficiency and dependability. Farmers who purchased Smith curers spread the word among their neighbors that it eliminated the cost of keeping a man more or less in the vicinity of the barn 24 hours a day to feed the wood fires, that the cost of fuel oil was only about $1.80 more than the cost of wood per barn of cured tobacco, that the tobacco cured more uniformly and had a better texture in that all of the natural oils were not cooked out of the leaves and that it was possible to obtain a higher price for the oil-burner cured tobacco. During the latter part of the 1930's, a shortage of fire wood, due to extensive cutting, was a factor in causing farmers to gradually convert from wood to oil-burner curers.

In the years 1936 through 1939, the Smith tobacco curer was sold principally in the flue-cured tobacco section of North Carolina, although

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