Mine & Smelter Supply Co. v. Comm'r of Internal Revenue

• Decision Date: 24 June 1948
• Docket Number: Docket No. 11609.
• Citation: 10 T.C. 1179
• Parties: THE MINE AND SMELTER SUPPLY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

10 T.C. 1179

THE MINE AND SMELTER SUPPLY COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 11609.

Tax Court of the United States.

Promulgated June 24, 1948.

ABNORMALITY— CLASS— SECTION 711(b)(1)(J)(i) AND (K), I.R.C.— In base period year 1937 petitioner, for the first time, issued to its executives and certain other key personnel a stock bonus, amounting to 28.01 per cent of its outstanding capital stock bonus, amounting to 28.01 per cent of its outstanding capital stock and having an aggregate par value in excess of 100 per cent of the basic salaries of those participants. The bonus was for the primary purpose of cementing the relationship and continued employment of the participants through giving them a stock ownership interest in the business, and, for a further purpose of partially rewarding them for past services. Held, that the stock bonus was a class of deduction separate from current basic salaries, that such deduction was abnormal in petitioner's business within subparagraph (J)(i), and that the abnormality was not a consequence of any of the factors enumerated in subparagraph (K)(ii); held, further, the limitation of subparagraph (K)(iii) is applicable. Lewis A. Dick, Esq., and Floyd K. Haskell, Esq., for the petitioner.

Frank M. Cavanaugh, Esq., for the respondent.

The respondent has determined against petitioner deficiencies and overassessments for the years and in the amounts as follows:

+-----------------------------------------------------------------------------+
                ¦                           ¦Calendar year 1941      ¦Calendar year 1942      ¦
                +---------------------------+------------------------+------------------------¦
                ¦                           ¦            ¦Over-      ¦            ¦Over-      ¦
                +---------------------------+------------+-----------+------------+-----------¦
                ¦                           ¦Deficiencies¦assessments¦Deficiencies¦assessments¦
                +---------------------------+------------+-----------+------------+-----------¦
                ¦Income tax                 ¦            ¦$2,114.85  ¦$707.75     ¦           ¦
                +---------------------------+------------+-----------+------------+-----------¦
                ¦Declared value excess      ¦$139.84     ¦           ¦221.57      ¦           ¦
                ¦profits tax                ¦            ¦           ¦            ¦           ¦
                +---------------------------+------------+-----------+------------+-----------¦
                ¦Excess profits tax         ¦7,741.68    ¦           ¦            ¦$0.55      ¦
                +---------------------------+------------+-----------+------------+-----------¦
                ¦Net amount                 ¦5,766.67    ¦           ¦928.77      ¦           ¦
                +-----------------------------------------------------------------------------+
                

The petitioner seeks redetermination of the asserted tax liability and also a determination of overpayments for each of the years 1941 and 1942. The parties have stipulated that petitioner paid its 1941 and 1942 taxes within three years before filing a claim for refund. The petition herein was filed July 22, 1946.

By stipulation of the parties at the hearing, the respondent has conceded the second assignment of error, relating to his failure to disallow for 1936 a certain bad debt deduction abnormality under section 711(b)(1)(J)(i) and (K), Internal Revenue Code, and the petitioner has conceded the third assignment of error, relating to the gain determined by the excess of the market value over cost of certain treasury stock distributed as a stock bonus to employees in 1941 and 1942. Effect to such stipulation will be given in the recomputation under Rule 50.

The only issue remaining in controversy is whether respondent, in determining petitioner's excess profits credit under the income method for the years 1941 and 1942, erred in refusing to disallow as a separate class of deduction abnormal for petitioner, under section 711(b)(1)(J)(i) and (K)(ii) of the code, the petitioner's distribution of 2,000 shares of its stock of an aggregate value of $130,000 as a stock bonus to 27 key employees in 1937, one of its base period years.

The proceeding has been submitted upon the pleadings, testimony, and exhibits, and a stipulation of certain facts, including attached exhibits. The stipulation is adopted as part of our findings of fact and included herein by reference.

FINDINGS OF FACT.

The petitioner, a Colorado corporation originally incorporated in 1895 and reincorporated in 1917, maintains its principal office in Denver, Colorado. It filed its income tax returns for 1941 and 1942 with the collector for the district of Colorado. It has at all times computed its excess profits credit on the income method.

For many years petitioner has been engaged in business principally as a wholesaler and retailer of various types of industrial machinery, equipment, tools, materials, etc., and as an agent in selling such types; and its customers include mining companies, contractors, dealers, government agencies, and individuals. In varying degrees petitioner has also engaged in designing and manufacturing special tools and equipment.

During the years 1933 to 1942, inclusive, the petitioner's corporate and business organization, type of business conducted, sales territory, plant facilities, and general methods of doing business remained the same, without material change other than normal omissions from and additions to the merchandise inventory carried for sale. Throughout those years there was a steady increase in volume of business in keeping with the general improvement in business conditions. During that time petitioner's general offices were located at Denver, where it maintained the company accounts and the offices of the several top executives who supervised the business transacted through its four divisions, each of the divisions being headed by a branch manager. The manufacturing division, known as the Marcy Mill Division, located in Denver, designed and manufactured, or farmed out for manufacture, special industrial tools and equipment in the nature of rock bit grinders, density controllers, pulverizers, concentrating tables, etc. The three sales divisions or branch offices, located in Denver, Salt Lake City, Utah, and El Paso, Texas, respectively, were each divided into six departments, each under the direction of a department head. Those departments were two functional departments consisting of division accounting and warehousing and four sales departments. The four sales departments consisted of the machinery department handling pneumatic and hydraulic metal and wood cutting machinery, equipment, etc.; the mill supply department handling various supplies, etc., used by industries and utilities; the electrical department handling electrical apparatus, motors, copper wire, supplies, etc.; and the chemical department handling equipment, supplies, etc., for chemical laboratories. The petitioner's activities in designing and manufacturing special equipment varied from time to time from 10 per cent to 20 per cent of its total business activities. In connection with its principal business of selling, petitioner's three branches each stocked approximately 14,000 items of merchandise during each of the years 1933 to 1939, and thereafter the number of items gradually increased, along with continued improved business conditions. Throughout the years the type and variety of products sold, and also those produced in petitioner's business, required the services of specially trained executives and other key men having both technical training and years of practical experience in that particular specialized business.

During the years from 1901 to 1929 the controlling stock interest in petitioner was owned by Joseph Seep. His son, A. H. Seep, was the local manager in Denver, and his son-in-law, one Fennessy, was president, invested with over-all administrative control centered in the general offices located in New York City. Because the western executives were dissatisfied with that arrangement, Joseph Seep transferred the petitioner's general offices to Denver in 1929, and A. H. Seep became its president. Subsequently, upon Joseph Seep's death in 1929, his stock in petitioner descended equally to his eight living children, all of whom lived in the eastern part of the United States, except A. H. Seep, who lived in Denver, and thereafter until 1937 the eastern stockholders retained the controlling interest and determined petitioner's general policies, including the compensation paid to executives and other key employees.

Commencing in 1930, petitioner's business suffered a sharp decline because of the general business recession and more particularly on account of the death of Joseph Seep, on whose personal credit the petitioner had previously borrowed capital, and A. H. Seep was forced to pledge his own securities as collateral for the company loans. Petitioner's volume of business was at its lowest ebb during 1932, and thereafter its business slowly improved, but in 1934 its financial affairs were in a critical condition, and also A. H. Seep, president of petitioner, had to withdraw from active participation in its business because of illness. A meeting was held at Denver in 1934 for consideration of petitioner's financial affairs by the western executives and representatives of the eastern stockholders. The latter refused to give petitioner any financial or other assistance and one stockholder suggested a sale, merger, or liquidation of petitioner. Several of the western executives, who had been with petitioner for over 25 years, expressed their willingness to assume the responsibility of overcoming petitioner's financial difficulties and pledge their services toward that end.

In March 1936 A. H. Seep died and was succeeded as president of petitioner by his son, Albert E. Seep, who had been in the company's employ since graduation from college in 1930 and had been vice president of petitioner since 1934. Albert E. Seep also...