28 T.C. 153 (1957), 50455, Pelton Steel Casting Co. v. C.I.R.

Docket Nº:50455.
Citation:28 T.C. 153
Opinion Judge:FISHER, Judge:
Attorney:Malcolm K. Whyte, Esq., John L. Palmer, Esq., and Richard L. Greene, Esq., for the petitioner. David H. Nelson, Esq., for the respondent.
Case Date:April 25, 1957
Court:United States Tax Court

Page 153

28 T.C. 153 (1957)




No. 50455.

United States Tax Court.

April 25, 1957

Page 154

Malcolm K. Whyte, Esq., John L. Palmer, Esq., and Richard L. Greene, Esq., for the petitioner.

David H. Nelson, Esq., for the respondent.

Petitioner failed to divide and distribute accumulated earnings or profits during a taxable year when, as the record shows, such an accumulation was not reasonably necessary to meet any threat of unrest amongst its own employees, significant fluctuation in the level of its production or operating profits, or reasonably anticipated additions or improvements to its plant and equipment. The failure to so divide its earnings and profits was pursuant to a plan developed by its minority shareholder (20 per cent) by which petitioner would use the accumulated funds, as well as additional borrowed funds to be secured by a mortgage on its plant and equipment, to purchase the interest of its major shareholder (60 per cent) who wanted to sell the business, and one other shareholder (20 per cent) allied with him, at a price which they were unable to obtain in the open market. The respondent's notice of deficiency was based upon the determination that petitioner had been availed of for the purpose of avoiding the imposition of surtaxes upon its shareholders by its failure to distribute, in whole or in part, earnings and profits accumulated during the taxable period.

Congress, in section 534 of the Internal Revenue Code of 1954, inserted a provision relative to the ‘ burden of proof’ in certain accumulated earnings tax cases which was, by later amendment, made to apply retroactively to the instant proceedings.


1. There is no expression of intent in the applicable 1954 Code sections or in the legislative history to alter or revise existing law relative to burden of proof under section 102, 1939 Code, except with respect to accumulations of profits beyond the reasonable needs of the corporation, and then only if the requirements of section 534 of the 1954 Code are met and if the issue is essential to a decision in a given case. To avoid the tax on undistributed section 102 net income, the burden remained with petitioner to prove the absence of a purpose to avoid the imposition of surtax upon its shareholders by the failure to distribute, in whole or in part, earnings or profits accumulated during the taxable year.

2. The question of whether or not petitioner's earnings and profits were permitted to accumulate beyond the reasonable needs of the business is not essential to a decision in this case as petitioner has failed to sustain its burden of proving the absence of the interdicted purpose. Assuming, arguendo, that it was significant that section 534 was complied with and that the burden of proof thus shifted to the respondent in this respect, the affirmative evidence demonstrates that the Ehne-Fawick deal did not represent a reasonable need of the business, and also that the earnings accumulated in 1946 were materially in excess of any reasonably anticipated capital expenditures or other exigencies of the business.

FISHER, Judge:

The instant proceedings involve the following deficiencies in surtaxes under section 102 of the 1939 Code determined by the respondent for the taxable years ended November 30, 1945 and 1946, respectively:

Year Amount
1945 $12,214.22
1946 69,746.66

Respondent, on brief, conceded no deficiency for 1945. The petition herein was filed on September 8, 1953, in response to a notice of deficiency[1] mailed to petitioner on August 24, 1953. The cause was heard on December 1 and 2, 1955. Section 534 of the Internal Revenue Code of 1954 was amended by Act of August 11, 1955, ch. 805, secs. 4 and 5, 84th Cong., 1st Sess., 69 Stat. 689, so as to apply retroactively to pending proceedings tried after the date of Page 155 enactment of such amendment. [2] Thereafter, on September 7, 1955, a notification[3] was mailed to the petitioner in the proper manner, and on October 6, 1955, petitioner timely submitted its statement[4] to respondent. Page 156 The issues for decision are (1) whether, within the meaning of section 102 of the Internal Revenue Code of 1939, petitioner was availed of during the taxable year ended November 30, 1946, for the purpose of avoiding the imposition of surtax upon its shareholders by permitting earnings and profits to be accumulated instead of dividing or distributing them, and (2) the extent, significance, and application to the instant case of changes in the burden of proof under the provisions of section 534 of the Internal Revenue Code of 1954. FINDINGS OF FACT. All of the stipulated facts are incorporated herein by this reference. Pelton Steel Casting Company, the petitioner, is a Wisconsin corporation and filed its tax returns for the periods in question on a fiscal year basis ending on November 30 with the then collector of internal revenue for the district of Wisconsin. Petitioner was organized and incorporated on December 14, 1925, as the outgrowth of the liquidation of a local division of a larger company which had proved unprofitable. The original charter provided Page 157 for 500 shares of $100-par-value capital stock. Its founders contributed the following amounts of capital with which they bought the inventory, plant, and equipment of the liquidated Pelton Steel Division of the Stowell Company:

A. J. Ehne $30,000
Allen Slichter 5,000
H. A. Leekley 5,000
Total original capital $40,000

The articles of incorporation were amended on June 20, 1928, increasing the authorized capital to 2,000 shares of $100-par-value capital stock. Ehne, at the time of incorporation, was a middle-aged man with a good deal of financial experience, who owned a pattern shop which made and sold patterns to foundries and was otherwise active in the steel casting business. Leekley had been employed for some time in the steel casting production department of petitioner's predecessor. Slichter was a younger man and had been employed for a period of about 5 years prior to petitioner's organization in the sales department of its predecessor company- after several months in that company's storeroom and production departments. Ehne was made petitioner's president and treasurer with general supervision and overall control of its operations. Leekly was made vice president, in charge of production. Slichter became petitioner's secretary and had charge of its sales. Except for a short period in the late 1920's when Ambrose Peters temporarily acquired a small interest in petitioner, there was no substantial change in its ownership until 1943 when Leekly sold out to Thomas L. Fawick, of Cleveland, Ohio. Fawick did not take any active part in petitioners' operations except to attend board meetings and to be available for consultation. Slichter assumed Leekley's responsibilities as regarded employee relations and works management. During the taxable period, petitioner's outstanding stock was held as follows:

Name Shares held
Arthur J. Ehne 898
Allen M. Slichter 300
Thomas L. Fawick 300
Lillian A. Brandt 1
Malcolm K. Whyte 1

The directors and officers of the company during the taxable period were:

Arthur J. Ehne Director President and treasurer
Thomas L. Fawick Director Vice president
Malcolm K. Whyte Director Vice president
Allen M. Slichter Director Secretary
Lillian A. Brandt Director Assistant secretary

Page 158 Petitioner produces steel castings by means of a process in which scrap steel melted at extremely high temperatures in electric furnaces is poured into molds formed of sand. In conjunction therewith, petitioner operates a pattern shop for its own purposes and for outside jobs. A long range comparison of steel casting production with that of steel production as a whole in this country, would show the former to be subject to severe cyclical fluctuations with too much to do in emergency periods and normally not enough in between. Steel casting, in general, can also be classified as a hazardous industry in view of the nature of the operation (pouring hot metal into fragile formed molds in sand); the volatile price of its principal raw material (scrap steel, being a marginal material, can fluctuate widely in price upon relatively slight variances in supply or demand); and the dependency of the industry's market (its product not being an end product) upon the markets of its respective customers. Viewing the steel casting industry as a whole, the railroad industry is generally the largest single customer for steel casting (taking up to 35 per cent of production). Tool and machinery manufacturers comprise another large market, taking nearly 25 per cent of production. Rolling mills also consume a large part of production. Four per cent of total production is scrapped and 1 per cent of sales is normally returned from customers as defective. The collection period for accounts receivable, upwards of 30 days, is slightly longer than other industries. The industry is highly competitive within itself (having a number of relatively small companies) and outwardly with the manufacturers of other materials such as welded fabrications and forgings. Petitioner's operation has been successful. Construction, papermaking, and agricultural heavy equipment manufacturers, and makers of machine tools, are its principal customers. The electric steel castings produced are not standard products nor are they themselves end products; but, rather, are custom...

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