4 T.C. 1215 (1945), 1060, Seminole Flavor Co. v. C. I. R.

Docket Nº:1060, 2332.
Citation:4 T.C. 1215
Opinion Judge:ARNOLD, Judge:
Attorney:Robert A. Littleton, Esq., for the petitioner. F. L. Van Haaften, Esq., for the respondent.
Case Date:April 30, 1945
Court:United States Tax Court

Page 1215

4 T.C. 1215 (1945)




Nos. 1060, 2332.

United States Tax Court

April 30, 1945

The stockholders of petitioner, which was engaged in the manufacture and sale of concentrates to bottlers for processing and sale of soft drinks to the public, in order to effectively overcome merchandising difficulties provide better corporation with the bottlers, create an increased demand by the public for the bottlers' products and thereby increase sales of

Page 1216

Robert A. Littleton, Esq., for the petitioner.

F. L. Van Haaften, Esq., for the respondent.

By these consolidated proceedings petitioner challenges deficiencies in tax determined by the Commissioner for the calendar year 1940, Docket No. 1060, and the nine-month period January through September 1941, Docket No. 2332. The tax deficiencies are as follows:

1940 1941
Income tax $41,381.30 $41,338.39
Declared value excess profits tax 4,065.70
Excess profits tax 9,487.87 112,680.02

The sole issue is whether Commissioner erred in including in petitioner's income under section 45 of the Internal Revenue Code the amounts of $177,441.25 for the taxable year 1940 and $242,248.15 for the taxable period in 1941 which were reported as income of the Seminole Flavor Co., Ltd., a partnership. FINDINGS OF FACT. The petitioner is a Tennessee corporation, organized on March 8, 1928, under the corporate name of Seminole Fruit Flavor Co. On or about December 31, 1929, the latter company acquired the assets of the Good Grape Co. in exchange for 550 shares of its capital stock. The corporate name was changed to Seminole Flavor Co. by amendment of the charter on January 29, 1932. Petitioner's principal place of business is in Chattanooga, Tennessee. Its tax returns for the taxable periods herein were filed with the collector of internal revenue at Nashville, Tennessee. Since November 7, 1934, through the taxable years petitioner's 750 shares of stock issued and outstanding have been held by the same stockholders without change. The term ‘ petitioner,‘ as hereinafter used, includes the Seminole Fruit Flavor Co. During the taxable periods the petitioner manufactured a full line of flavors, sometimes referred to as a ‘ concentrate,‘ which it sold solely to bottlers engaged in the business of bottling soft drinks. The bottler diluted this concentrate with simple sirup, or sugar and water, aged the solution 24 to 72 hours, and then added carbonated water to make the bottled beverage distributed for consumption. Petitioner's concentrates were sold under the trade names of Double-Cola, Double-Orange, Double-Lemon, Double-Strawberry, Double-Peach, Double-Grape, Double-Root Beer, etc. Petitioner's Double-Cola concentrate was introduced to the trade late in 1935 or early in 1936. In 1937 its sales of Double-Cola concentrate amounted to approximately 75 percent of its total sales, and during the taxable periods herein such sales amounted to more than 90 percent of the total sales. Double-Cola is manufactured from a Page 1217 secret formula consisting of approximately 16 different ingredients. The formula was perfected over a period of years by the efforts of C. D. Little and J. S. Foster, president and treasurer, respectively, of the petitioner, and no other persons have knowledge of the component parts of the formula. When the petitioner brought out its Double-Cola concentrate its Cola accounts were very limited. Its fruit flavors, and a Cola concentrate known as Jumbo-Cola, were handled principally by independent bottlers and company owned or controlled bottling plants. Petitioner's first efforts to distribute Double-Cola followed the usual procedure of employing traveling salesmen to sell its product to established bottlers. Petitioner also attempted to interest people who wanted to go into the bottling business in the use of Double-Cola. Wherever possible petitioner entered into an agreement with the bottler granting him an exclusive franchise for bottling Double-Cola in his territory. Under this type of franchise the bottler agreed to bottle the flavors manufactured by petitioners and no other flavors. Other bottlers executed nonexclusive franchise agreements which did not restrict their use of flavor concentrates to petitioner's products. Both types of franchise agreements provided for advertising, merchandising, and supervising services by the petitioner with respect to and over the bottler's operations. Certain advertising matter was to be furnished the bottler free of cost, and the bottler agreed to put up and erect all advertising according to petitioner's instructions and to feature and advertise Double-Cola as his leading drink. Bottling and sanitary requirements were set up, petitioner's representatives could inspect the bottler's plant to ascertain whether the requirements were being met, and the bottler agreed to submit samples of the Double-Cola he was distributing for analysis by petitioner and obligated himself to keep and maintain the standards set by petitioner for its product. The number of petitioner's Double-Cola accounts materially increased during the calendar years 1936, 1937, and 1938. Thereafter the number of Double-Cola accounts gradually declined through 1943, but petitioner's total sales increased each year from 1936 through the calendar year 1943. Petitioner's Double-Cola accounts were scattered over the United States and its facilities and organization were so inadequate that it was unable to give its bottlers the advertising, merchandising, and supervisory services called for in their franchise agreements. During 1937, 1938, and 1939 petitioner received numerous complaints from its bottlers about the unsatisfactory services petitioner was rendering. Petitioner lost a large number of bottling accounts during these years, some of which were potentially very good accounts, because it did not assist the bottlers with satisfactory advertising and merchandising services. Among other things, the bottlers Page 1218 demanded newspaper, billboard, moving picture, and radio advertising and sampling campaigns, none of which was being furnished by petitioner. In 1936 petitioner brought into its home office the manager of its bottling plant at La Grange, Georgia, James M. Geeslin, and placed him in charge of the distribution of its products. Geeslin had developed a profitable business for the petitioner at La Grange during a period of depression after taking over a company owned plant that appeared to be hopelessly insolvent. Prior thereto he had been a specialty man for the petitioner, interviewing bottlers and assisting them in advertising and merchandising their products. After working with company owned or controlled bottling plants and with plants owned by individual bottlers, Geeslin became convinced that company owned plants were far superior. He found that many of the independent bottlers did not know how to do business, did not have the proper facilities for doing business, and needed supervision. A few months after he took charge of petitioner's distribution Geeslin discussed with Little the necessity of a medium through which the petitioner could exercise more control over, and could work closer with, the independent bottlers for the purpose of expanding their sales and distribution. Subsequent events further convinced Geeslin of the merits of his idea and he continued to urge upon the officers and the directors the necessity and desirability of setting up some form of organization which would improve petitioner's advertising and merchandising services and at the same time would work more closely with the bottlers. Two of petitioner's directors opposed the idea; two were interested but not entirely convinced. Early in 1937 Geeslin obtained permission from Little to move his office, and the offices of about five other employees, from the manufacturing building to the Hamilton National Bank Building. Lack of space at the factory, the availability of space at the bank building, better accommodations, and a nicer atmosphere in which to meet representatives of the bottlers, prompted this move. Geeslin was in complete charge of the office and the salesmen. At the annual meeting of petitioner's stockholders on April 29, 1938, their concern over the company's situation is recorded in the following minutes:

The President submitted a statement of the operation of the company during 1937, and also a comparative statement of the operation of the company during the first three months of 1938 as compared with the first three months of 1937.

The question of whether or not the company would surrender its charter and reincorporate, or would create or take over another company and use one as a manufacturing company and the other as a sales company was discussed at length, and the directors were authorized to make investigation as to what would be the most feasible plan, if there should be any change at all. Page 1219 Many other things with reference to the operation of the business were discussed at length. There was extensive discussion as to whether or not the company should adopt a six ounce or seven ounce bottle to be used along with the twelve ounce bottle, but do definite action was taken on this. During 1938 and 1939 petitioner's officers and directors continued to discuss whether petitioner should change its method of sales promotion and distribution and the merits of the various plans suggested. They recognized that petitioner had more bottling plants to service than its facilities or organization could handle and that complaints of the bottlers about inadequate service were...

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