A. Finkl & Sons Co. v. Comm'r of Internal Revenue

• Citation: 38 T.C. 886
• Decision Date: 19 September 1962
• Docket Number: Docket No. 44728.
• Parties: A. FINKL & SONS COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: United States Tax Court

38 T.C. 886

A. FINKL & SONS COMPANY, PETITIONER,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 44728.

Tax Court of the United States.

Filed September 19, 1962.

[38 T.C. 886]

Carl J. Batter, Esq., for the petitioner.

John W. Holt, Esq., for the respondent.

Petitioner's claim for relief under section 722, I.R.C. 1939, denied.

FORRESTER, Judge:

Respondent has denied petitioner's application for relief under section 722 ¹ for the year 1944 in the amount of $844,206.73. The issues presented for our determination are: (1) Whether petitioner's plant rehabilitation and modernization program was an event ‘unusual in the experience of the taxpayer’ within the

[38 T.C. 887]

meaning of section 722(b)(1) or increased petitioner's ‘capacity for production’ within the meaning of section 722(b)(4); (2) whether petitioner or the industry of which it was a member was depressed due to temporary economic events during the base period within the meaning of section 722(b)(2); and (3) whether changes in management personnel constituted a ‘change in management’ within the meaning of section 722(b)(4).

FINDINGS OF FACT.

Some of the facts have been stipulated and are so found.

I. Background. A. General.

Petitioner is a corporation incorporated under the laws of the State of Illinois in 1902. It kept its books and filed its income and excess profits tax returns on a calendar year, accrual basis for all years material hereto. Its income and excess profits tax returns for the taxable year 1944 were filed with the collector of internal revenue for the first district of Illinois.

In computing its excess profits credit for 1944, petitioner employed the invested capital method (sec. 714). Under such method its credit is $313,142.48. Under the income method (sec. 713) its credit would be $298,849. [F N2]

Its excess profits net income for each of the base period years is as follows (adjusted to reflect revenue agents' changes):

+-----------------------+
                ¦1936 ¦$267,784.49 ¦
                +---------+-------------¦
                ¦1937 ¦451,033.42 ¦
                +---------+-------------¦
                ¦1938 ¦8,945.85 ¦
                +---------+-------------¦
                ¦1939 ¦287,831.33 ¦
                +---------+-------------¦
                ¦Aggregate¦1,015,595.09 ¦
                +---------+-------------¦
                ¦Average ¦253,898.77 ¦
                +-----------------------+
                

B. Products and Operations.

Petitioner is the leading die block manufacturer in the world. It engages in the manufacture of die blocks for the drop-forge industry, the automobile industry, and for other large manufacturers and railroads maintaining drop-forge equipment. Its largest customer is the drop-forge industry. These die blocks are manufactured from alloy or carbon steel. The petitioner also produces commercial open

[38 T.C. 888]

die and drop forgings, principally heavy forgings, ³ for a number of durable goods industries. It either partly or completely machines some of its production. Its customers are many and diversified; they cover the whole range of the metal-fabricating industries, and they include but are not limited to the automobile industry, the agricultural implements industry, the railroad industry, and the marine equipment industry. The petitioner does not manufacture its own steel or alloy steel but rather purchases it. The products of the petitioner are primarily secondary consumer products; that is, they are consumed by industries in the process of making goods and as such do not become a part of the consumer product.

Among the many methods of mass production used in modern durable goods industries there is none more important than those of drop forging and upsetting. By these two processes, which may both be referred to generally by the term ‘drop forging,‘ it is possible to duplicate accurately metal parts of surprisingly intricate design in large quantities with remarkable speed. The method used generally consists of heating the metal to a plastic condition and forming it in dies which contain the desired shape in negative or mirror form. The dies are affixed or attached to drop-hammers in the case of drop forgings and in mechanical hydraulic forging machines in the case of upset work.

The die blocks after being forged are heat-treated and rough-machined on the face and shank (opposite) sides and tested for proper hardness. The die block may become the petitioner's end product or it may be consumed by the petitioner as a finished die in making commercial drop forgings to its customers' specifications. The commercial forgings are heat-treated by the petitioner and when machined are machines either rough or finished. If finished, extremely close tolerances are required and attained in the machine shop process.

In August 1923, William F. Finkl⁴ (whose duties are more fully described below), then petitioner's chief metallurgist, obtained a patent on a steel-hardening process which he had perfected. The patent consisted of a carbon-chromium-nickel-molybdenum steel from which the die blocks were made. William assigned the patent to petitioner who licensed certain steel companies,

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including petitioner's suppliers and competitors, to make alloy steel under the patent. Under the licenses, the steel companies could not use the patent in the manufacture of steel for sale to die block customers other than petitioner. However, one competitor, Heppenstall Company (hereinafter referred to as Heppenstall) which also made steel was permitted to produce die blocks under the patent. Such permission was granted at the insistence of petitioner's customers who wanted to be certain that more than one source of supply for die blocks was available. The patent was very effective and resulted in the virtual elimination of competition from those who made die blocks from other types of steel.

At all times here relevant Heppenstall sold its products at prices identical to those of petitioner. Thus, the two companies generally competed on the basis of quicker delivery and more efficient service.

C. Company History.

Anton Finkl founded what was to become the business of the petitioner in 1879, in Chicago, Illinois. Anton's three sons, Charles E., Fred, and Frank, assisted him in his business. Petitioner was incorporated in 1902, and acquired the business theretofore operated by Anton as an individual proprietorship.

The petitioner corporation has always been a closely held family corporation. Decisions have been made generally by a concerted, unanimous agreement of all the members. For the years material to this case it was both owned and managed by the Finkl family. Charles, son of Anton, held the controlling interest in the petitioner when he died on July 29, 1933. At the death of Charles his interest in the petitioner passed to his wife Elizabeth and his son William. Elizabeth Finkl died October 14, 1941, and at that time passed her remaining interest in the petitioner to her son William, who was then the president of the petitioner.

During the years 1936 through 1939 the petitioner had two operating plants designated as Plant No. 1 and Plant No. 2. Plant No. 1 was built in 1902 and by 1918 it had been enlarged to consist of a representative forge plant. During the years material to this case it could process blooms and billets up to 16 inches in cross section. Plant No. 2 was built in 1923-1924 and further expanded during the 1920's. Its facilities were much more extensive than those of Plant No. 1, which was limited to die blocks in size up to 12 by 18 by 20 (inches); Plant No. 2 would process blooms and ingots as large as 54 inches, round or square, having a maximum weight of 110,000 pounds. Production was directed to the two plants in accordance with the size of the steel required. Plant No. 2 did some finishing work for Plant No. 1, but fundamentally each plant was self-contained. Plant No. 1 produced die blocks, some commercial forgings (the heavier commercial

[38 T.C. 890]

forging was produced in Plant No. 2), drop forgings, and alloy steel bars and rounds. Plant No. 3 was erected in 1940 and put into service in 1941. Plant No. 4 commenced operations in 1942.

Plant No. 3 was constructed because petitioner's management realized the need for an expansion in the machine shop and heat-treating departments in order to perform the anticipated orders from the United States Army, Navy, and Maritime Commission. This expectation was to prove fully justified. Such additional facilities were also required for the production of breech rings and blocks for various types of guns demanded by divers military units. In 1941 the United States War and Navy Departments issued certificates of necessity with respect to these facilities.

Plant No. 4 was erected at the instruction of the Industrial Planning Section of the United States Army Air Corps which required facilities for greater

production of die blocks. II. Personnel Changes and Plant Rehabilitation Immediately Prior to and During Base Period. A. Personnel.

Anton was the founder of petitioner and served as its president until his death in 1938. In the early formative years he had complete managerial responsibility. As the size of the business increased and the production and financial problems became more complex, he gradually relinquished many of these duties. About 1923, Charles became general manager and assumed the major duties in the financial end of the business. His brothers, Fred and Frank, became active in management somewhat later but mainly in the production phase. Charles died in 1933 and thereupon his son William (the metallurgist) began to assume many of Charles' duties although Anton remained the titular head of the business.

During Charles' tenure as general manager plant modernization with a view to increased efficiency was undertaken at regular intervals, but the modernization programs in the 1920's were not as extensive as those undertaken later. Throughout the later years of Charles' administration all members of the family recognized the need for a complete overhaul of plant facilities. Many companies which completed with petitioner had...