Docket No. 22251 24711 28952 37180.
11-12-1929
MARC EIDLITZ & SON, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Ward Loveless, Esq., Cornelius J. Sullivan, Esq., George M. Wolcott, Esq., and Arthur N. Colton, Esq., for the petitioner. Bruce A. Low, Esq., for the respondent.
Ward Loveless, Esq., Cornelius J. Sullivan, Esq., George M. Wolcott, Esq., and Arthur N. Colton, Esq., for the petitioner.
Bruce A. Low, Esq., for the respondent.
Respondent determined deficiencies in income and profits taxes for the calendar years 1919 of $4,965.24, 1920 of $16,579.91, and 1921 of $15,777.88, and income taxes for the calendar years 1922 of $122.06, 1923 of $106.56, and 1925 of $66.17. Petitioner claims invested capital of trade name and good will and the allowance of depreciation in respect thereof. For 1919, 1920, and 1921, special assessment is claimed under section 327.
FINDINGS OF FACT.
Petitioner is a corporation, incorporated on December 24, 1917, under the laws of the State of New York, with principal office at 41 East 42nd Street, New York City. It succeeded a copartnership, known as Marc Eidlitz & Son, which had been formed in 1884 by Marc Eidlitz and his son, Otto M. Eidlitz, and which in turn succeeded an individual proprietorship conducted by Marc Eidlitz in his own name after 1854. After the death of Marc Eidlitz in 1892, the copartnership consisted of Otto M. and Robert J. Eidlitz.
The business of petitioner and its predecessors was the construction of fireproof buildings of various kinds, including offices, banks, hospitals, hotels, clubs, warehouses, and residences. Among the structures erected by the firm are the J. P. Morgan Bank Building, Guaranty Trust Co. Building, New York Telephone Building, Chase National Bank Building, Roosevelt Hospital, Western Union Telegraph Building, Western Electric Building, Yale Club, New York Stock Exchange, Harkness Memorial, and others of similar character. In 1910 the firm was offered a contract for the construction of the Woolworth Building, but declined it. Since 1904 all of its contracts have been on a cost-plus basis, whereby the client undertakes to pay to the petitioner as commission a percentage of the cost of the building to be erected, making monthly advances to cover petitioner's payments to subcontractors. This type of contract requires little cash for the conduct of business and involves a limited risk for the contractor. Its reputation for integrity and ability is the controlling element in securing business upon this basis. Ten years ago petitioner was the only firm in New York City which confined its business to cost-plus contracts, and only one other has done so since. At incorporation and prior thereto the firm enjoyed the reputation of performing excellent work, of having the friendly cooperation of union labor, and of dealing along lines of the highest standard of integrity with its subcontractors. Its position as a building contractor was outstanding.
It was the firm's practice to refuse contracts for the erection of cheap or speculative structures even for its regular clients. Little of its business was procured in competition, most of it coming unsolicited and without advertising. Many of its clients it has retained for three generations. Its relations with some were such that work was frequently begun without fixing the commission. Most of petitioner's employees have been with the firm for many years, and have very rarely been laid off for lack of work.
The partnership was jealous of its name and resisted incorporation until 1917.
The certificate of incorporation was signed and acknowledged December 22, 1917, by Otto M. Eidlitz, Robert James Eidlitz, and Harry N. French, and filed with the Secretary of State December 24, 1917, and with the New York County Clerk December 26, 1917. In the certificate it was stated that the number of its shares of capital stock was 7,000 of a par value of $100 each and the amount of capital with which it began business was $700,000. Its duration was to be perpetual. The shares were subscribed for by Otto M. Eidlitz, 4,200, Robert James Eidlitz, 2,799, and Harry N. French, 1. The first directors were these three persons and Percy Vermilya and Archibald C. Heaphy, the last named two being associated with the partnership.
On December 31, 1917, the copartnership, by formal offer and acceptance, sold and conveyed to the corporation the following described property:
Jobs ______________________________ $366,188.79 Job suspense ______________________ 4,227.91 Owners and sundry clients _________ 10,929.07 Commissioner of public works ___________________________ 5,684.75 Cash in bank ______________________ 99,100.56 Advances, traveling expenses, etc _____________________________ 1,102.88 Petty cash ________________________ 800.00 Investment Liberty loan ___________ 13,474.72 Bills receivable __________________ 5,500.00 Furniture and fixtures ____________ 6,000.00 Equipment and material ____________ 4,741.10 Automobile ________________________ 300.00 Horse and cart ____________________ 200.00 ____________ Total _________________________ 518,249.78
The offer and acceptance expressly excepted the good will and right to use the partnership name from the above sale and conveyance.
The consideration for this transfer was the issuance by the petitioner of 4,500 shares of its stock — 2,700 shares to Otto M. Eidlitz and 1,800 to Robert J. Eidlitz.
On the same date, December 31, 1917, Otto M. Eidlitz and Robert J. Eidlitz offered to purchase 2,500 shares of petitioner's capital stock for $300,000, said stock to be issued to Otto M. Eidlitz 1,500 shares, Robert J. Eidlitz 999 shares, and Harry N. French 1 share. A check for $300,000, dated December 31, 1917, was drawn by "Otto & Robert Eidlitz," payable to petitioner, was endorsed by petitioner and passed through the bank.
On the same date, December 31, 1917, the directors resolved to purchase for $300,000 the good will of the copartnership and the right to use the copartnership name in accordance with an agreement of the same date. On the same date, the copartnership "bargained and sold, granted and conveyed" to petitioner, its successors and assigns, "the good will of the said firm of Marc Eidlitz & Son, with the privilege to use the name thereof, and to continue to use the said name * * * for the period of three years after both the said Otto M. Eidlitz and Robert James Eidlitz cease to be officers of the said corporation and to take an active part in the conduct of the business of the said corporation"; and the petitioner agreed to change its name within such three years. A check for $300,000, dated January 2, 1918, was drawn by petitioner to "Otto & Robert Eidlitz," was endorsed by them, and passed through the bank.
The good will acquired was set up on petitioner's books January 1, 1918, at $300,000; the total assets appearing upon its books at that date, including good will, aggregated $818.249.78.
In 1917 Otto M. and Robert J. Eidlitz were about 54 and 56 years of age respectively. The life expectancy of Robert, who did not contemplate leaving the business, was then 18 years. The agreement of sale of good will and firm name was incorporated in the wills of the partners. A subsequent agreement, appearing in the will of Otto M. Eidlitz, provides:
That the right of the party of the second part to use such name, Marc Eidlitz & Son, in so describing itself as aforesaid shall continue and is to be exercised only for a period of two years after the name of the party of the second part has been changed, as provided for in said agreement of December 31, 1917.
On December 31, 1917, sufficient unsolicited business was coming to the partnership to keep it busy and there was no reason to expect it to drop off. As shown by the books, its net income, its gross income, and the tangible assets used in its business, were as follows for the years indicated:
------------------------------------------------------------------------- | | | Tangible Year | Net income | Gross income | assets ----------------------------|--------------|---------------|------------- 1911 ______________________ | $173,251.11 | $248,987.63 | $291,224.52 1912 ______________________ | 222,624.33 | 310,682.87 | 328,222.52 1913 ______________________ | 181,176.16 | 288,848.45 | 359,342.69 1914 ______________________ | 246,188.71 | _____________ | 463,776.02 1915 ______________________ | 273,239.04 | 422,043.89 | 404,793.12 1916 ______________________ | 156,185.32 | 319,112.87 | 572,245.68 1917 ______________________ | 93,615.72 | 377,570.82 | 518,249.78 | | |
The books of petitioner showed the following net earnings after payment of income taxes:
1918 ____________________________________________ $77,579.25 1919 ____________________________________________ 85,512.03 1920 ____________________________________________ 371,663.41 1921 ____________________________________________ 356,331.10 1922 ____________________________________________ 300,875.28
Prior to incorporation Otto M. and Robert J. Eidlitz held, respectively, a 60 and 40 per cent interest in the partnership. For 1917 the partnership deducted $87,500, representing salaries of $57,500 and $35,000 to Otto and Robert J. Eidlitz, respectively, in computing petitioner's tax liability, and after incorporation petitioner paid them these respective sums until Otto's death in 1928. No salaries were paid for the years 1911 to 1916, inclusive, but, in computing the amount due certain individuals entitled to a portion of the partnership earnings, $45,000 was deducted as annual salaries for the two partners.
During the years 1917 to 1921, inclusive, petitioner had no government contracts.
During the years 1919, 1920, and 1921 there were abnormal conditions affecting the capital or income of the petitioner.
OPINION.
STERNHAGEN:
The petitioner, by its petition, sought to overcome the respondent's determination on three points: (1) That its statutory invested capital under section 326 should include $300,000 more than the respondent has allowed, by reason of the transactions which resulted in its acquisition of trade name and good will; (2) that, failing this, the evidence shows an abnormal condition of capital or income under section 327 (d) justifying special assessment by the comparative method of section 328, the measure of which is reserved by the parties for future hearing, if necessary, under Rule 62; and (3) that its net income should be reduced by a deduction under section 234 (a) (7) for exhaustion of its right to use its name.
1. The first question was expressly withdrawn by petitioner at the opening of trial and counsel stated that no evidence would be introduced on the point. In their brief, petitioner's counsel seek to retract their waiver because of a misunderstanding of the law. To treat the issue as restored would be wholly unwarranted and unfair. Trial was not had nor argument submitted on this issue, and, for all we know, respondent's defense was shaped to fit a trial with this issue removed. This was unlike an attempt to stipulate the legal effect of admitted or agreed facts. Such a stipulation would not prevent consideration and decision on the point or counsel's presentation of a legal view at variance with the stipulation. Ohio Cloverleaf Dairy Co., 8 B. T. A. 1249. Here the only stipulation was in respect of certain facts, documents and data placed in the record after the express waiver of the first issue and directed only at the two remaining issues. Both the facts and the law of the first issue were eliminated. To this question, therefore, the Board gives no consideration and leaves the petitioner in the position determined by respondent in the notices of deficiency.
2. The evidence clearly shows that the petitioner from the time of its organization in 1917 was in an unique position which warrants the finding that there were abnormal conditions affecting its capital or income during the excess-profits-tax years here in question. Its invested capital, although substantial, was only remotely responsible for its earnings. The profits were attributable in large measure to conditions not properly reflected therein, such as its reputation of long standing, the character of its personnel, and other intangible factors commonly included in good will. The corporate name, however well regarded, was, we think, of decidedly less importance than the personnel. The practice exclusively to contract on a cost-plus basis, with the client providing current outlay, was unlike that of any other taxpayer in the industry. This was not a high rate of profit on a nominal capital; it was a profit largely on something other than invested capital. Irrespective of whether its exclusion from invested capital be directly because of section 331, its abnormality is otherwise apparent. While exclusion by reason of section 331 would not necessarily be a statutory abnormal condition, Morris & Co., 1 B. T. A. 704, such exclusion would also not be a complete obstruction to special assessment where abnormal conditions plainly existed which made the normal plan of the excess-profits tax fairly inapplicable. Clarence Whitman & Sons, Inc., 11 B. T. A. 1192.
There is, in our opinion, ample ground for further consideration of special assessment as contemplated by Rule 62.
3. The petitioner's claim to a deduction under section 234 (a) (7) of a reasonable allowance for exhaustion of its right to use its name is not well founded in law or in fact. Omitting, as unnecessary, any decision as to the nature of the transaction by which this right was ostensibly acquired, or the consideration therefor, it is in any event plain that it was acquired simultaneously and compositely with the good will. Good will, being of indefinite or unlimited duration, is not ordinarily subject to exhaustion and is not susceptible of amortization out of income as contemplated by the statutory deduction. In the absence of segregation of cost as between the alleged trade name and the good will, there is no basis to which annual depreciation of the former could be applied. Market Supply Co., 3 B. T. A. 841; Charles P. Limbert Co., 9 B. T. A. 1390. The evidence does not justify the view urged by petitioner that all the cost is applicable alone to the right to use the name, and it may be doubted whether in its nature this is demonstrable by evidence. See American Steel Foundries v. Robertson, 269 U. S. 372. It may also be doubted whether the formal segregation by the parties in 1917 of the good will and name from the other enumerated assets has any recognizable basis. See Metropolitan Bank v. St. Louis Dispatch Co., 149 U. S. 436, 446; In re Leslie-Judge Co., 272 Fed. 886; certiorari denied, 256 U. S. 784. It is by no means clear from the New York decisions whether, in view of the identity of the incorporators, who chose the name, and the partners in the existing firm, who knowingly permitted the name to be taken, the petitioner could, if the Eidlitz brothers voluntarily dissociated themselves from the corporation, be prevented from using its established name or whether after the death of the survivor of the two Eidlitz brothers there would be damage to anyone else or right in anyone else ever to complain. See White v. William G. White, 145 N. Y. S. 743; Wyatt v. Hall's Portrait Studio, 128 N. Y. S. 247.
There is further practical difficulty in petitioner's theory, even if the contract for separate purchase of the right to use the name be unquestioned as to its effect. The name was to be used for three years after the Eidlitz brothers' withdrawal. This withdrawal was taken by petitioner at its latest date, which would be the date of death of the surviving brother, and the longest period was taken as the probable mortality period shown by an experience table. Treating these factors as accepted data and treating the formula as a method for arriving at a period of performance of the contract, there is still the fact that no actual exhaustion of investment is to be anticipated to justify a deduction out of income. The statutory deduction for exhaustion is for the purpose of anticipating annually an inevitable or reasonably probable disappearance of capital investment and setting up out of income a fund to equal the original investment when it disappears. Here, however, the petitioner has three years after the withdrawal of the Eidlitz brothers and the consequent loss of the advantage inherent in their participation to adjust itself to a new name, to take all the steps possible to retain the substance of the investment, to protect itself against the loss which the exhaustion deduction contemplates. We disregard the later voluntary two-year extension of this adjustment period.
Under these circumstances, we are of opinion that there is no "reasonable allowance for exhaustion of property used in the business" to which the petitioner is entitled for any of the years in question, and the respondent's determination of petitioner's net income is sustained.
These being reasons adequate, we think, to support the decision, it is unnecessary to give extended consideration to the apparent simulation of substantial transactions in an attempt to fit them into the pattern of the revenue act. However high the motive, the refinements of legal theory may not always command recognition if they are inconsonant with the normal course of the law, and when the arguments as to the sanctity of the particular methods used are pressed too far it requires the application of the useful though indefinite doctrine that form must give way to substance.
The proceeding will be held awaiting further action by the parties under Rule 62.