Differential Steel Car Co. v. Comm'r of Internal Revenue

• Decision Date: 23 February 1951
• Docket Number: Docket No. 23909.
• Citation: 16 T.C. 413,88 U.S.P.Q. 451
• Parties: DIFFERENTIAL STEEL CAR COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

16 T.C. 413

88 U.S.P.Q. 451

DIFFERENTIAL STEEL CAR COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 23909.

Tax Court of the United States.

Promulgated February 23, 1951.

John J. Kendrick, Esq., G. Charles Scharfy, Esq., and Robert Kniffin, Esq., for the petitioner.

Clarence E. Price, Esq., for the respondent.

1. INCOME— ABNORMAL.— Whether profit realized by petitioner from sale of equipment manufactured to order of one customer but sold to another customer was ‘abnormal income‘ within the meaning of section 721(a) (1) or (2), Internal Revenue Code, not decided, but even if it were ‘abnormal income,‘ held no part of it was attributable to other years, under section 721(b).

Id.— CAPITAL GAIN.— Held, further, that the gain resulted from a sale of capital assets held for more than 6 months, section 117(j).

2. EQUITY INVESTED CAPITAL.— Claimed increases in equity invested capital held properly disallowed except for sum paid in settlement of second mortgage judgment against plant acquired by predecessor. Section 718(a)(2).

Id.— OPERATING DEFICIT.— Held, that deficit of merged corporation properly disallowed as not meeting requirements of section 718(a)(7) and 718(c)(5).

3. DEDuCTION— BUSINESS EXPENSE.— Royalty payments made in taxable years held to be deductible as ordinary and necessary expenses in carrying on business. Section 23(a)(1)(A).

FINDINGS OF FACT AND OPINION.

TIETJENS, Judge:

This case involves the following tax deficiencies asserted against petitioner:

+---------------------------------------------------------+
                ¦    ¦          ¦Declared value¦              ¦           ¦
                +----+----------+--------------+--------------+-----------¦
                ¦Year¦Income tax¦excess-profits¦Excess profits¦Total      ¦
                +----+----------+--------------+--------------+-----------¦
                ¦    ¦          ¦tax           ¦tax           ¦           ¦
                +----+----------+--------------+--------------+-----------¦
                ¦1943¦0         ¦$18,667.57    ¦$123,250.05   ¦$141,917.62¦
                +----+----------+--------------+--------------+-----------¦
                ¦1944¦$2,778.56 ¦8,870.67      ¦73,607.28     ¦85,256.51  ¦
                +---------------------------------------------------------+
                

 2,778.56 27,538.24 196,857.33 227,174.13
                

Several issues have been conceded and will be reflected in Rule 50 computation. The following issues remain for disposition:

(1) Whether the amount of $8,582.92 received by petitioner in 1943 as profit on the sale of certain equipment as (a) ordinary income as treated by respondent, or, as contended by petitioner, either (b) abnormal income within section 721 of the Internal Revenue Code, or (c) long term capital gain within section 117(j);

(2) Whether respondent, for the calendar years 1943 and 1944, properly determined petitioner's excess profits tax credit; and

(3) Whether respondent properly disallowed as deductions from gross income the amounts of $120,000 and $95,250 for the calendar years 1943 and 1944, respectively, claimed to have been paid by petitioner as royalties for the use of patents in those years.

For clarity, general findings of fact applicable to all issues first will be made, then findings and decision on each issue separately.

GENERAL FINDINGS OF FACT.

The facts stipulated are so found and the stipulation by reference is made part of our findings.

The income and excess profits tax returns for the years here involved were filed with the collector of internal revenue for the tenth district of Ohio. On June 13, 1949, petitioner filed with the collector of internal revenue at Toledo, Ohio, its claim for refund of income tax paid by it for the year 1943 in the amount of $7,521.28.

Petitioner is an Ohio corporation with its principal office at Findlay, Ohio. It was incorporated in 1927 under the name of Differential Car Manufacturing Corporation and is the continuing corporation which resulted from a merger on December 30, 1937, of The Differential Steel Car Company with petitioner which at that time changed its name to Differential Steel Car Company.

During the taxable years and from the time of incorporation petitioner and its predecessor were engaged in the manufacture and sale of specially designed haulage equipment for mines, railroads, quarries, etc.

Findings of Fact— Issue No. 1.

Almost all of petitioner's products were manufactured and sold under special orders, that is, ‘tailor-made‘ for particular customers.

In 1937, a customer contracted with petitioner for the manufacture of three haulage units. Petitioner, due to delays in securing equipment was unable to make the specified delivery date and the customer refused to accept the units. The units were nevertheless completed in October 1937 at a cost of a great deal more than originally estimated and remained on tracks at petitioner's plant.

Meanwhile there was a rising market for such equipment and petitioner continued negotiations with the customer hoping satisfactorily to consummate the sale. These negotiations fell through finally in 1941.

Petitioner's operations were such that a switch engine was needed to transfer cars under construction from one bay of the plant to another as the manufacturing process proceeded. For about six months in 1942 and four months in 1943 one of the unsold three units was used as a switch engine to supplement the engine ordinarily used.

In 1943 this unit was sold at a profit of $8,582.92. The unit was of the same general class of equipment normally manufactured and sold by petitioner in the regular course of business.

This was the only time a customer ever had refused delivery of equipment contracted for with petitioner.

In its excess profits tax return for 1943, on schedule A, petitioner claimed abnormal income as a deduction in the amount of $8,582.92. This the Commissioner disallowed with the explanation in the deficiency notice that it had not been substantiated.

Opinion— Issue No. 1.

Petitioner contends that the entire, profit of $8,582.92 realized from the sale of equipment manufactured in 1937 for sale and delivery to a particular customer in that year but which was sold to someone else in 1943, constituted ‘abnormal income‘ within subsection (a)(1) of section 721, Internal Revenue Code,¹ attributable to a previous year within subsection (b) of that section and thus was properly excludible from its excess profits net income for the year 1943 as provided in subsection (c) of that section.

The basis for petitioner's argument is the ‘unique‘ set of circumstances, so far as petitioner's business is concerned, which gave rise to the profit in 1943. It claims that in the normal course of its business the profit would have been realized in 1937 and so was properly attributable to that year instead of 1943.

We need not decide whether the item was properly classifiable as abnormal within the meaning of section 721(a)(1). Even if it be conceded that it was so classifiable yet petitioner must fail in its claim, for petitioner has not shown the income to be attributable to another year as required by section 721(b). It is claimed that because the equipment sold was manufactured for sale in 1937 the profit on the sale in 1943 should be attributed to 1937. But for all this record shows we cannot determine what profit, if any, would have been realized had the sale been made in 1937. Petitioner's president testified that the equipment cost a great deal more than originally estimated. The cost of the equipment is shown on petitioner's tax return, but nowhere can we find what the 1937 contract sale price was. Nor can we be certain whether or not the cost shown on the return was the original cost of producing the equipment, or included elements of cost, such as the cost of sales efforts, properly attributable to the years intervening between 1937 and 1943. Furthermore, there is evidence that there was a rising market for equipment of this kind in the early 1940's and we think that the sale finally made was primarily the result of increased demand for the product. In the circumstances, we cannot properly attribute any portion of the $8,582.92 to years other than 1943, and petitioner must fail in his claim for relief under section 721. Geyer, Cornell & Newell, Inc., 6 T.C. 96.

We turn now to petitioner's alternative contention, that the $8,582.92 profit was derived from a sale of ‘property used in the trade or business‘ within the meaning of section 117(j), Internal Revenue Code, and therefore should be ‘considered as gains * * * from sale * * * of capital assets held for more than 6 months,‘ as provided in that section. Petitioner's argument is that while the equipment in question was initially part of petitioner's stock in trade, yet, beginning in 1942 and up until the sale in 1943 the equipment was put to use in its business and was thereby converted into ‘property used in the trade or business,‘ the conversion dating from the beginning of use in 1942. We see no reason why this contention should not prevail. Cf. Reginald Denny, 33 B.T.A. 738; Leland Hazard, 7 T.C. 372; and Nelson A. Farry, 13 T.C. 8. Since the equipment was held in such use for more than six months the gain on its sale should have been treated as a long term capital gain, and we so hold.

Findings of Fact— Issue No. 2.

In 1927 petitioner's predecessor acquired through purchase at a mortgage foreclosure sale, for $18,200, certain property known as its North Plant, such assets being taken upon the books of petitioner's predecessor at approximately that figure. In the same year the predecessor corporation paid to the United States the sum of $20,000 in settlement of a judgment obtained by the Government in the same foreclosure proceedings on a second mortgage which it held on the property. This $20,000 was charged off to profit and loss and deducted by petitioner's predecessor on its 1927 income tax return and such amount has never since been restored on the books.

At the time the plant was acquired it contained some machinery and equipment placed there by...