Mid-State Prods. Co. v. Comm'r of Internal Revenue

• Decision Date: 15 February 1954
• Docket Number: Docket No. 24793.
• Citation: 21 T.C. 696
• Parties: MID-STATE PRODUCTS COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

21 T.C. 696

MID-STATE PRODUCTS COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 24793.

Tax Court of the United States.

Promulgated February 15, 1954.

Fred H. Kelly, Esq., for the petitioner.

Elmer E. Lyon, Esq., for the respondent.

1. The petitioner was organized to engage in buying shell eggs and the selling of frozen eggs. It decided to explore the possibilities of entering the business of producing and selling dried eggs. Expenditures made in its fiscal year 1941 in the course of such exploration, in acquainting itself with the prospects for the purchase of dried eggs by the Federal Government, and in preparing itself so that it might compete for business in such buying program, were charged to an account entitled ‘Deferred Development and Pre-Operating Expense,‘ from which they were charged off and deducted in its fiscal years 1942 and 1943 as expenses in filling orders for the first 6,000,000 pounds of dried eggs sold to the Government. Held, that the expenditures constituted capital costs, but which have not been shown to represent the cost of wasting assets which would give rise to amortization or depreciation deductions for the years claimed.

2. The respondent did not err in disallowing the deduction of attorneys' fees and costs of options to purchase property expended by petitioner in its fiscal year 1941, but deducted by it as repairs on its return for its fiscal year 1942.

3. The amounts paid to J. W. Nunamaker, Sr., as compensation for services rendered to petitioner and for the use of equipment owned by him, for the fiscal years 1942 and 1943, found to be reasonable and held that the payment of portions thereof by negotiable promissory notes constituted effective payment, the deduction of which was not barred by the provisions of section 24(c) of the Internal Revenue Code.

4. Held, that petitioner has not shown error by the respondent in his disallowance of a portion of the depreciation deductions claimed by petitioner for its fiscal years 1942, 1943, 1944, and 1945.

5. The respondent did not err in disallowing the claimed deduction of a fee paid by petitioner for plans for a piece of machinery, which plans were not shown to have been discarded or abandoned even though the machine was not built.

6. Held, on the facts, that $35,000 paid by petitioner whereby one of its officers and stockholders acquired the stock of another and certain disputes and litigations between them, and to which petitioner had been made a party, were settled, did not constitute ordinary and necessary expenses incurred and paid by petitioner in carrying on its business and respondent did not err in disallowing the deduction claimed therefor.

7. In 1946 and 1947, the Commodity Credit Corporation offset against amounts due petitioner for dried egg deliveries in those years, certain amounts disallowed as reimbursable costs which had been paid to the petitioner in its taxable years 1944 and 1945, under contracts on a cost-plus-a-fixed-processing-fee basis, and which had been reported by petitioner in these years as income. Held, that under the provisions of section 3806(a)(2) of the Internal Revenue Code, the petitioner's income for 1944 and 1945 is to be reduced by the respective amounts of such offsets.

The respondent has determined deficiencies in the petitioner's income and excess profits taxes as follows:

+------------------------------------------------+
                ¦                     ¦            ¦Excess       ¦
                +---------------------+------------+-------------¦
                ¦Year ended           ¦Income tax  ¦profits tax  ¦
                +---------------------+------------+-------------¦
                ¦Mar. 17-Nov. 30, 1941¦$154.87     ¦             ¦
                +---------------------+------------+-------------¦
                ¦Nov. 30, 1942        ¦            ¦$24,510.38   ¦
                +---------------------+------------+-------------¦
                ¦Nov. 30, 1943        ¦1,592.74    ¦             ¦
                +---------------------+------------+-------------¦
                ¦Nov. 30, 1944        ¦            ¦19,666.48    ¦
                +---------------------+------------+-------------¦
                ¦Nov. 30, 1945        ¦422.02      ¦31,438.63    ¦
                +------------------------------------------------+
                

The issues for decision are whether the respondent, in his determination of the deficiencies herein, erred (1) in disallowing as deductions in 1942 and 1943, expenditures made in 1941 but deducted in the years stated as deferred development and pre-operating expense; (2) in disallowing $1,264.18 of the deduction claimed by petitioner on its 1942 return as covering repairs; (3) in disallowing a portion of the deductions claimed by petitioner on its 1942 and 1943 returns as compensation paid to J. W. Nunamaker, Sr.; (4) in disallowing a portion of the deductions claimed by petitioner on its 1942, 1943, 1944, and 1945 returns for depreciation; (5) in disallowing a portion of a deduction claimed by petitioner on its 1944 return for engineering services; (6) in disallowing a deduction claimed by petitioner on its 1945 return as an ‘item of expense covering a payment of $35,000 made to James J. Motycke‘; and (7) in failing to determine that petitioner was entitled to the application of section 3806(a)(2) of the Internal Revenue Code in a determination of its income for 1944 and 1945, due to disallowances of reimbursable costs by the Commodity Credit Corporation.

FINDINGS OF FACT.

Part of the facts have been stipulated and are found as stipulated.

The petitioner is an Illinois corporation, with its principal office in Indianapolis, Indiana. Formerly, its name was Mid-State Frozen Egg Corporation. Its income and excess profits tax returns for the years herein were prepared from books kept on an accrual basis, and were filed with the collector of internal revenue for the district of Indiana.

The petitioner was organized in March 1941, to engage in the business of purchasing shell eggs and selling frozen eggs. Its capital stock was $25,000, divided into 250 shares of a par value of $100 each, all of which were outstanding through the years involved herein. Upon organization, the 250 shares of authorized stock were issued, 150 shares to J. W. Nunamaker, Jr.; 25 shares to J. W. Nunamaker, Sr., and Blanche Nunamaker; 55 shares to James J. Motycke; and 20 shares to Ray Elster. The 25 shares issued to J. W. Nunamaker, Sr., and Blanche Nunamaker were transferred on October 10, 1942, to John W. Nunamaker, Jr.

‘Deferred Development and Pre-Operating Expense.‘

On May 12, 1941, a meeting of petitioners' board of directors was held, at which the chairman stated that one of the purposes of the meeting ‘was to consider enlarging the operations of the corporation by engaging in the business of dried eggs.‘ He stated further that there seemed to be a potential market for dried eggs and ‘that his information was to the effect that the United States Government was or might be interested in purchasing dried egg powder.‘ After discussion, a resolution was adopted authorizing and directing J. W. Nunamaker, Jr., and Motycke, the president and secretary of the corporation, to investigate the desirability and feasibility of entering the business of drying eggs and selling dried egg products and to report their findings with reference to the possible market for such products and the availability of physical plant facilities. They were to keep a true and accurate account of the time spent and the expenses incurred by each of them in connection with the said investigations.

As the possible location of its dried egg business, the petitioner thereafter acquired an option to purchase certain property in Greensburg, Indiana, paying $500 for the option. Nunamaker and Motycke learned, or were aware, of a dried egg purchasing program of the Surplus Marketing Administration of the Department of Agriculture. They made some trips to Washington to explore the matter, in the course of which they made certain representations, including the plan for the dried egg plant in Greensburg, and on July 11, 1941, petitioner received a letter from the Surplus Marketing Administration, reading as follows:

This will confirm our understanding concerning the construction of facilities at Greenburg (sic), Indiana, to dry approximately 3,000,000 pounds of dried whole eggs per annum.

This Department will purchase during the fiscal year ending June 30, 1942, as large a quantity of dried whole eggs as can be obtained at reasonable price levels up to 100,000,000 pounds. Should you construct your facilities, as part of the purchase program referred to above, this Department will purchase from you, at reasonable price levels in accordance with our normal offer and acceptance procedure and provided that prices at which you offer eggs are competitive with other offers we receive, your entire plant's production up to 3,000,000 pounds.

Although it is clearly understood that no commitments are made for any period beyond June 30, 1942, should the dried egg purchase program be continued, your concern will receive equitable consideration with all other firms producing dried eggs.

On some undisclosed date, the petitioner learned that a desirable property located in Indianapolis might be available. This property was a 4-story, brick building, which at one time had been used for the manufacture of school supplies, but currently was being used for storage purposes.

At a meeting of petitioner's board of directors on August 18, 1941, a resolution was adopted to the effect that the option to purchase the Greensburg property be not exercised and that negotiations for the lease of the Indianapolis property, with an option to purchase, be initiated. The resolution directed that the $500 paid for the option on the Greensburg property be charged to an account on petitioner's books to be known and captioned as ‘Deferred Development and Pre-Operation Expense.‘¹ The president and secretary were directed ‘to attempt to effect the transfer of the letter of intent, certificate of necessity and project priority...