Steel or Bronze Piston Ring Corp. v. Comm'r of Internal Revenue, Docket No. 16271.
| Decision Date | 24 October 1949 |
| Docket Number | Docket No. 16271. |
| Parties | STEEL OR BRONZE PISTON RING CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
1. Relief under section 721, Internal Revenue Code, denied to manufacturer of piston rings in the absence of proof that petitioner's income for 1942 and 1943 was due in any material part to the development of patents, formulae, and manufacturing processes in prior years, rather than to an increased wartime demand for petitioner's products.
2. Respondent sustained on other issues for lack of proof showing error in his determination. Albert Stump, Esq., for the petitioner.
Lester M. Ponder, Esq., for the respondent.
This proceeding involves deficiencies in declared value excess profits and excess profits taxes for the calendar years 1942 and 1943, as follows:
+----------------------------------+
¦ ¦Declared value¦ ¦
+----+--------------+--------------¦
¦Year¦excess profits¦Excess profits¦
+----+--------------+--------------¦
¦ ¦taxes ¦taxes ¦
+----+--------------+--------------¦
¦1942¦$5,784.08 ¦$54,577.32 ¦
+----+--------------+--------------¦
¦1943¦7,654.37 ¦54,710.49 ¦
+----------------------------------+
The petitioner alleges that the Commissioner erred (1) in denying relief under section 721, Internal Revenue Code, for the years 1942 and 1943; (2) in failing to allow the correct amount of invested capital to be used in determining excess profits credit for 1942 and 1943; (3) in failing to allow the correct amount of unused excess profits credit carry-over from 1940 and 1941; (4) in determining petitioner's opening and closing inventories for 1942 and 1943; (5) in disallowing a portion of the traveling, entertainment, and general expenses claimed by the petitioner in 1942 and 1943; and (6) in disallowing a portion of the salary paid to George Deeb, Jr., son of petitioner's president, in 1943. Some of the facts have been stipulated and are found accordingly.
The petitioner is an Indiana corporation, with its principal office and place of business located at Indianapolis, Indiana. Its returns for 1942 and 1943 were filed with the collector of internal revenue for the district of Indiana. The returns were made for a calendar year and on an accrual basis, in accordance with petitioner's method of keeping its books.
Petitioner was organized October 14, 1929, as successor, under a reorganization, to Garsix Manufacturing Co. That company, hereinafter called Garsix, was organized March 17, 1926, to take over a business, formerly operated as a partnership, of manufacturing pistons and piston rings of various types. Its assets were said to consist of tangible property of a value of $20,000 and intangible property of a like amount. Garsix was not successful in its operations and on February 4, 1929, it was placed in receivership. The receivership action was brought by George D. Gardner, a stockholder of the corporation, who alleged in his complaint that the company was indebted to him for moneys advanced for operating expenses in the amount of $40,000. The other stockholders were Nancy Lee Gardner, George D. Gardner's wife, and Walter J. Six. Under contract dated June 11, 1929, Six transferred his interest in the business to Gardner.
One of Garsix's employees, George Deeb, was appointed receiver for the corporation in the receivership proceeding. He filed with the court an inventory dated February 28, 1929, showing assets of a total value of $4,794.34. He filed with the court a final statement on October 7, 1929, in which he reported that all of the debts of the company had been paid and that the company was then on a dividend-paying basis. The report was approved by the court. The receivership continued until the petitioner was organized to take over the business.
Petitioner's authorized capital stock consisted of 500 shares of no par value, 75 shares of which were issued to George Deeb, 1 share to George D. Gardner, and 124 shares to Nancy Lee Gardner.
George Deeb was first employed by Garsix in 1928. He became president of the petitioner upon its organization and has served in that capacity until the present time.
Under the contract of June 11, 1929, between Six and Gardner, it was agreed that each of them should have the continued use of certain patents pertaining to the manufacture of piston rings which they owned jointly and that either might sell or license his one-half interest therein.
The petitioner began operation on a small scale, with limited equipment. It continued the business of manufacturing piston rings substantially as it had been operated by Garsix. Most of the piston rings then in use, and particularly those used in automobile motors, were made of cast iron. Most of the rings manufactured by the petitioner were made of tempered steel, bronze, or alloys. These rings had been found to be superior to cast iron rings for many uses.
The petitioner operated at a loss every year until 1941. At one time, about 1937, it was deserted by all but one of its employees. The employees numbered from about 16 to 25 during the period 1929 to 1937.
Both the wife and sister of George Deeb, petitioner's president, furnished funds of their own from time to time to meet the pay roll and other operating expenses. The former, Charline Deeb, advanced between $18,000 and $25,000 of her own funds and the sister a lesser amount.
In the first years of its operations the petitioner had a great many of its rings returned to it as unsatisfactory. It continued its research in materials and manufacturing methods, experimenting with various types of steel and other metals and acquiring whatever assistance it could from metallurgists and research laboratories. It developed certain different kinds of machines for use in its manufacturing processes such as cutting, loading, and forming machines.
By about 1936 or 1937 the petitioner had developed formulae and improved manufacturing methods by which it was able to produce rings that were satisfactory to its customers.
Petitioner used about the same manufacturing methods and equipment in the taxable years 1942 and 1943 that it had used in the years just preceding. Much of its machinery was especially designed for a particular purpose and was not standard. However, petitioner had the use of certain standard equipment furnished by the United States Government for manufacturing rings for war use.
Among petitioner's principal customers were Bendix Corporation, Liquid Carbonic Corporation, Crane Co., Barco Manufacturing Co., Chrysler Corporation, Yuba Manufacturing Co., and Worthington Pump & Machinery Corporation.
Most of petitioner's production during 1942 and 1943 went into manufacture of equipment or materials for war use. The petitioner's rings were used in airplane engines, landing gears, gun turrets and other war equipment. Uniformed officers of the armed forces were stationed in petitioner's plant from time to time to inspect and expedite its war production.
Petitioner's gross sales, gross profit or loss from sales, and net income or loss, as reported in its income tax returns for the years 1929 to 1943, inclusive, were as follows:
+--------------------------------------------+
¦ ¦ ¦Gross profit or¦ ¦
+----+-----------+---------------+-----------¦
¦Year¦Gross sales¦(loss) from ¦Net income ¦
+----+-----------+---------------+-----------¦
¦ ¦ ¦sales ¦or (loss) ¦
+----+-----------+---------------+-----------¦
¦1929¦$1,936.42 ¦ ¦($6,303.85)¦
+----+-----------+---------------+-----------¦
¦1930¦23,539.97 ¦ ¦(1,157.37) ¦
+----+-----------+---------------+-----------¦
¦1931¦19,529.51 ¦ ¦(1,233.00) ¦
+----+-----------+---------------+-----------¦
¦1932¦10,044.47 ¦ ¦(16.60) ¦
+----+-----------+---------------+-----------¦
¦1933¦6,156.09 ¦ ¦(8,627.55) ¦
+----+-----------+---------------+-----------¦
¦1934¦9,738.68 ¦ ¦(400.20) ¦
+----+-----------+---------------+-----------¦
¦1935¦8,001.05 ¦ ¦(1,363.78) ¦
+----+-----------+---------------+-----------¦
¦1936¦9,940.12 ¦ ¦(1,714.99) ¦
+----+-----------+---------------+-----------¦
¦1937¦8,948.20 ¦ ¦(1,914.33) ¦
+----+-----------+---------------+-----------¦
¦1938¦5,533.94 ¦ ¦(7,171.06) ¦
+----+-----------+---------------+-----------¦
¦1939¦8,462.59 ¦ ¦(225.61) ¦
+----+-----------+---------------+-----------¦
¦1940¦11,660.29 ¦ ¦(433.68) ¦
+----+-----------+---------------+-----------¦
¦1941¦45,274.29 ¦$10,879.35 ¦6,214.60 ¦
+----+-----------+---------------+-----------¦
¦1942¦129,592.59 ¦60,696.94 ¦28,890.10 ¦
+----+-----------+---------------+-----------¦
¦1943¦212,755.24 ¦102,576.48 ¦37,725.17 ¦
+--------------------------------------------+
The petitioner occupies a minor position in the piston ring industry. Large manufacturers produce many times more rings than petitioner. Some of them manufacture steel rings and other types in competition with the petitioner. Petitioner did not employ a sales force or advertise extensively, as did some of the larger manufacturers. Most of its sales and contact with the public were handled by its president, George Deeb. During 1942 and 1943 petitioner did not use in its business any patents or exclusive trade rights which gave it any material advantage over its competitors.
There was little change in either the cost of materials used in the production of the rings or the selling price of the rings which the petitioner manufactured over the period 1939 to 1943, inclusive.
In determining the deficiencies herein the Commissioner reduced the 1942 opening inventory, as reported in the return for that year, from $67,478.41 to $5,000 and the 1943 opening inventory from...
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