E.B. & A.C. Whiting Co. v. Comm'r of Internal Revenue, Docket No. 11359.

• Decision Date: 16 January 1948
• Docket Number: Docket No. 11359.
• Citation: 10 T.C. 102
• Parties: E.B. & A.C. WHITING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

10 T.C. 102

E.B. & A.C. WHITING COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 11359.

Tax Court of the United States.

Promulgated January 16, 1948.

1. The petitioner, a manufacturer of brush materials, developed a new product, utilizing to a small degree waste formerly sold as such. Experimentation in the development resulted in sales during the fiscal year 1940, but continued in that year. Held, on the facts, that for purpose of computation of excess profits tax, an operating loss of the department devoted to the development of the new product was not a deduction within section 711(b)(1)(J)(ii), Internal Revenue Code; held, further, that such loss was the consequence of change in type, manner of operation, size, and condition of petitioner's business. Restoration to base period income therefore denied.

2. Reasonable amount of compensation for personal services actually rendered by executive officer of petitioner determined on the facts.

3. Bonus to executive officer held, on the facts, not accruable in the fiscal year 1943 when voted, in an indefinite amount subject to a maximum, and contingent upon financial condition in the opinion of the treasurer, who was the executive officer involved; it not appearing that the amount was determined upon during the year or that the amount was ever accrued on the corporate books. Laurence F. Casey, Esq., for the petitioner.

M. L. Sears, Esq., for the respondent.

This proceeding involves deficiencies for the fiscal years ended May 31 in 1942 and 1943, as follows:

+-----------------------------------------------------+
                ¦                                 ¦1942     ¦1943     ¦
                +---------------------------------+---------+---------¦
                ¦Income tax                       ¦$6,127.82¦         ¦
                +---------------------------------+---------+---------¦
                ¦Declared value excess profits tax¦9,757.65 ¦$1,423.53¦
                +---------------------------------+---------+---------¦
                ¦Excess profits tax               ¦44,396.72¦38,769.69¦
                +-----------------------------------------------------+
                

The petitioner claims an overpayment of excess profits tax in 1942 and excess profits tax and declared value excess profits tax in 1943. The issues are whether the Commissioner erred in disallowing as deductions $72,000 in 1942 and $22,000 in 1943 as compensation for services of petitioner's president and treasurer; whether the additional amount of $50,000, authorized but not accrued in 1943, is deductible as compensation for the same officer; and whether petitioner is entitled to disallowances of ‘losses‘ under the provisions of section 711(b)(1)(J) of the Internal Revenue Code. The stipulation of facts is by reference incorporated herein as part of our findings of fact.

FINDINGS OF FACT.

Petitioner is a Vermont corporation, organized in 1913 and having its principal place of business in Burlington, Vermont. During the taxable years it kept its books on the accrual basis and filed its tax returns with the collector at Burlington, Vermont.

The business of petitioner at all times has been that of importing and processing fibers, horse hair, and related materials and the sale thereof to manufacturers throughout the United States. During the taxable years sales were made to most of the broom and brush manufacturers in the United States. At all times some of its waste material was sold to upholsterers and hair concerns. It is the successor of a business established in 1873 by E. B. and A. C. Whiting.

The petitioner imported its raw materials from Mexico, from which it obtained materials called Tampico or istle, Brazil, India, Java, Africa, Canada, and Argentina. The petitioner processed the raw materials to meet the needs of its customers. It has from 15 to 20 standard mixtures acceptable to all manufacturers and about 8,400 formulae for grades of fiber, which are used from time to time. It averages about 300 special orders from manufacturers each day. At times petitioner produces material for a specified purpose and submits samples to prospective buyers. During 1941 to 1943, inclusive, it had about 450 customers. It supplied about 80 per cent of the country's requirements of grades of materials known as Tampico or istle, tula, palmyra, and pita; about 70 per cent of bass; and about 40 per cent of horse hair. Sales of petitioner and the variety of its mixtures of crude material exceed those of any other brush fiber manufacturer in the United States. No other manufacturer produces a complete line of brush fibers.

Thomas A. Unsworth, who was born in 1876, has been engaged in the brush and broom fiber business since 1893 and has been with petitioner since 1913. He became president of petitioner about 1920, and during the taxable years was president, treasurer, and a director of petitioner. He had been a stockholder since incorporation of the company, originally owning half of the common stock and acquiring additional common stock in 1920.

During the taxable years Unsworth exercised general supervision over the affairs of petitioner, purchased all of the raw material used by it, made practically all of the sales of its product, and arranged for loans necessary to conduct its affairs. Obtaining raw material was one of the most valuable services performed by him for petitioner. Scarcity of labor in Mexico and lack of sufficient ocean transportation from foreign countries made it more difficult than formerly for petitioner to obtain its requirements of raw material during the taxable years. The contacts petitioner had with dealers and brokers for the purchase of raw materials were made by Unsworth. Such contacts enabled petitioner to acquire raw material that other manufacturers could not purchase.

Petitioner has never employed salesmen for the express purpose of selling its products. Sales were frequently made by Unsworth as the result of solicitations made on the telephone and visits by him to the places of business of brush manufacturers. He made sales every day he was in a position to do so. At least 60 per cent of petitioner's business was done on orders received without any price specified.

Prior to and during the taxable years, Unsworth, when extra duties required it, frequently worked at the plant until 11 o'clock in the evening. Much of such additional work was performed during the period when petitioner was developing a product sold under the trade name of tulatex. He personally prepared a large number of formulae used by the petitioner and originated the formula type of operation in the industry. There is no other man in the brush fiber industry comparable to Unsworth. The bank from which petitioner borrowed money during the taxable years required Unsworth to endorse the notes given for the loans.

During the taxable years petitioner was able to sell practically all of the products it had on hand, including all old and obsolete items. In October 1941 Unsworth purchased for petitioner at a competitive public auction sale conducted by a United States Marshal at Port Everglades, Florida, 110 carloads of crude istle and a quantity of resin and phosphate, paying therefor $60,000, which amount was $2,500 in excess of the highest bid of five other bidders. The amount paid for the istle was about 2 1/4 cents a pound, or 6 cents a pound under the market price f.o.b. Laredo or Brownsville. The low price paid for the material enabled petitioner to make an additional profit of about $350,000 in the fiscal year 1942. Negotiations conducted by Unsworth with railroads for a reduction of freight rates on the material resulted in a saving of about $60,000 on the cost of transporting the shipment to petitioner's plant.

In September 1935 petitioner opened a separate account on its records under the name of ‘Hairtex Department,‘ later called ‘Tulatex Department.‘ The operation of the department became profitable during the fiscal year 1941, but the department was discontinued as of May 31, 1941, upon the transfer of the land, buildings, equipment, and material used in the department, together with other buildings, to the Queen City Tulatex Corporation or to the Burlington Realty Co., corporations all of whose stock was acquired by petitioner on June 2, 1941. The land and buildings were transferred to the Burlington Co., which leased them to the Tulatex Corporation for a rental of $26,671.50 in the fiscal year 1942 and of $81,014.85 the next year.

During the fiscal year 1942 Unsworth was required to do considerable traveling to Mexico in connection with the procurement of istle. At that time Mexico prohibited the export of crude istle except under its regulations. In November 1941 Unsworth caused the organization of a corporation, known as Fibras Duras, under the laws of Mexico, to process raw istle and supply the needs of the Tulatex Corporation for curled istle for exclusive use in the production of tulatex and for sale to upholsterers and foreign users without violating export regulations of Mexico. The stock of Fibras Duras was owned by Unsworth. About 90 per cent of the tulatex produced by the Tulatex Corporation was manufactured from material acquired from Fibras Duras.

During a period of three and one-half years, commencing in about February 1941, Unsworth devoted some time negotiating the cancellation of an agreement entered into by petitioner in February 1941 for the distribution and sale of tulatex. During the taxable years the negotiations were conducted on behalf of the Tulatex Corporation.

Orders issued by the War Production Board during petitioner's fiscal year 1941 or 1942 restricted the use of rubber and temporarily prevented the production of tulatex by the Tulatex Corporation. In the taxable years Unsworth attended a great many conferences with officials in Washington to obtain permission to use curled istle waste with reclaimed rubber in the production of tulatex. Such permission was granted, but restricted to war orders. During that period he also spent some time...