Fort Howard Paper Co. v. Comm'r of Internal Revenue, Docket No. 3127-65.
| Decision Date | 27 December 1967 |
| Docket Number | Docket No. 3127-65. |
| Citation | 49 T.C. 275 |
| Parties | FORT HOWARD PAPER COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
William A. Cromartie and Douglas L. Barnes, for the petitioner.
Robert M. Burns and John L. Pedrick, for the respondent.
Petitioner for 35 years capitalized only the direct costs of labor and materials connected with self-constructed items. Overhead expenditures were in part allocated to inventory and in part deducted currently. Respondent was fully aware of petitioner's practice and had frequently adopted the same method in requiring petitioner to capitalize repair items which petitioner had deducted on its returns. On a second audit of petitioner's 1961 return, respondent determined that a portion of overhead expenses should be attributed to self-constructed assets and capitalized. Held, petitioner, under all the circumstances involved, utilized an acceptable method of accounting for such overhead and its treatment thereof will not be disturbed. Held, further, that certain fringe items and the cost of this petitioner's drafting department were properly treated as overhead.
Respondent determined a deficiency in the amount of $212,354.52 in the Federal income tax of petitioner for the taxable year ended December 31, 1961. After concessions and agreements with respect to various adjustments raised by the deficiency notice, the issues remaining are: (1) Whether the additional examination of petitioner's records and the issuance of a deficiency notice thereunder were improper under section 7605;1 (2) whether respondent's determination was arbitrary and unreasonable and therefore should be disregarded, or alternatively not be accorded the usual presumption of correctness; and (3) if such determination is not to be disregarded, whether petitioner utilized the proper method of accounting for the cost of ‘self-constructed assets.’
Some of the facts are stipulated and are found accordingly.
Petitioner Fort Howard Paper Co. (sometimes hereafter referred to as Fort Howard) is a Wisconsin corporation with its principal offices in Green Bay, Wis., at the time of the filing of the petition herein. Petitioner timely filed its Federal income tax return for the calendar year 1961 on the accrual basis with the district director of internal revenue in Milwaukee, Wis.
Fort Howard is a manufacturer of paper and paper products. During the period 1953 through 1961, petitioner's gross sales ranged from approximately $15 million to $30 million. In 1961, the Fort Howard product line consisted exclusively of manufactured sanitary papers, such as paper towels, napkins, and tissues. Nearly 975 different items, including various grades and sizes of paper products, were manufactured. Six large paper-making machines were in operation at the plant. Petitioner also operated pulpers and equipment for the processing of dried pulp into a usable state for the paper machines. In addition, petitioner used certain machinery to convert logs into groundwood pulp and to process scrap paper and similar products into pulp ingredients when they could be appropriately used in the final product.
Petitioner operated its own fleet of motor vehicles and over 80 forklift trucks and towmotors. In addition, the company produced its own electric power from coal-operating steam generators, having in 1961 a maximum capacity of approximately 20,000 kilowatts. In 1961, petitioner purchased no electric power from sources outside the plant, with the exception of small amounts used in warehouses not directly connected with the main plant.
For many years prior to and including 1961, petitioner's plant was operated on a full 24-hour basis, usually for 13 days in each 2 weeks. Occasionally, the plant would be shut down because of repairs, or during a special ‘shut down’ period of 2 weeks (once a year) when many employees were on vacation and only ‘skeleton’ crews were on duty. To operate at this level, three full production crews were maintained in 1961 for each paper-making machine.
In 1961, approximately 1,100 persons were employed by petitioner, 190 to 200 of whom were repair and maintenance personnel in nonsupervisory capacities. Included in the repair and maintenance personnel were skilled mechanics and repairmen, carpenters, electricians, machinists, millwrights, and pipefitters. Petitioner also maintained and operated in its plant ‘repair shops,‘ which were capable of handling most machine and plant repairs. Most of the employees on the repair and maintenance crews worked on the day shift (7 a.m.-3:30 p.m.) with smaller crews available on the evening (3 p.m.-11 p.m.) and midnight shifts (11 p.m.-7 a.m.). In order to keep the plant in continuous operation, all repair and maintenance personnel were subject to call at any time for emergency work.
At least as far back as 1939 and up to and including 1961, the Fort Howard management followed a policy of using its maintenance and repair personnel from time to time in the renovation of its buildings and the construction and installation of assets having useful lives of more than 1 year (hereinafter referred to as self-construction projects or self-constructed assets). To avoid having any ‘slack,’ ‘idle,‘ or ‘loss' time, repair and maintenance personnel were used only during their spare time, when they could be so employed without disturbing normal operations. Such personnel were not diverted from regular repair or maintenance projects to work on self-construction projects. No special tools or machinery were acquired for use by such personnel in connection with such activities. Projects were often planned a year or more in advance of actual construction, but completion was sometimes delayed several years because work was done only on a ‘fill-in’ basis.
Since the time of its inception (1919), Fort Howard management followed a policy of determining the size of its repair and maintenance staff on the basis of the need for continuous operation of the regular producing equipment. During peak periods of maintenance, it was often necessary to supplement the repair and maintenance force with anywhere from 25 to 75 employees borrowed from the manufacturing (producing) departments.
Self-construction work performed by repair and maintenance personnel was the subject of a written description and was designated a ‘project.’ Examples of such ‘projects' included the following (as recorded from petitioner's record of Jobs in Progress— 1961):
+-----------------------------------------------------------------------------+
¦Date opened ¦Job No. ¦ ¦
+-------------+---------+-----------------------------------------------------¦
¦May 11, 1953 ¦618 ¦Make two 4-roll wrappers. ¦
+-------------+---------+-----------------------------------------------------¦
¦Aug. 6, 1956 ¦892 ¦Install paper converting plyfold machine. ¦
+-------------+---------+-----------------------------------------------------¦
¦Oct. 3, 1956 ¦10 ¦Make and install Yankee hood. No. 3 paper ¦
+-------------+---------+-----------------------------------------------------¦
¦ ¦ ¦machine. ¦
+-------------+---------+-----------------------------------------------------¦
¦Oct. 3, 1956 ¦11 ¦Heater, fan and ductwork for Yankee hood, No. 3 ¦
+-------------+---------+-----------------------------------------------------¦
¦ ¦ ¦paper machine. ¦
+-------------+---------+-----------------------------------------------------¦
¦Jan. 14, 1958¦118 ¦Build four wide singlefold towel log bundlers. ¦
+-------------+---------+-----------------------------------------------------¦
¦Oct. 29, 1958¦198 ¦Make and install automatic reel for No. 3 paper ¦
+-------------+---------+-----------------------------------------------------¦
¦ ¦ ¦machine. ¦
+-------------+---------+-----------------------------------------------------¦
¦Nov. 25, 1958¦202 ¦Fort Howard work on water treatment part of ¦
+-------------+---------+-----------------------------------------------------¦
¦ ¦ ¦No. 51 building. ¦
+-------------+---------+-----------------------------------------------------¦
¦Nov. 25, 1958¦204 ¦Fort Howard work on ledger processing part of ¦
+-------------+---------+-----------------------------------------------------¦
¦ ¦ ¦No. 51 building. ¦
+-------------+---------+-----------------------------------------------------¦
¦Nov. 25, 1958¦207 ¦Lighting for No. 51 building. ¦
+-------------+---------+-----------------------------------------------------¦
¦Nov. 25, 1958¦208 ¦Power wiring for No. 51 building. ¦
+-------------+---------+-----------------------------------------------------¦
¦Nov. 25, 1958¦209 ¦Heating and ventilation for No. 51 building. ¦
+-------------+---------+-----------------------------------------------------¦
¦Feb. 11, 1959¦236 ¦Install air-conditioning unit and ventilation for ¦
+-------------+---------+-----------------------------------------------------¦
¦ ¦ ¦offices, first and second floors, No. 49 building. ¦
+-------------+---------+-----------------------------------------------------¦
¦Feb. 11, 1959¦237 ¦Heating for offices, second floor, No. 49 building. ¦
+-------------+---------+-----------------------------------------------------¦
¦Feb. 11, 1959¦238 ¦General construction of office rooms, first floor, ¦
¦ ¦ ¦No. 49 building....To continue reading
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