Docket No. 20198.
Carl Tangeman, Esq., and John C. Elam, Esq., for the petitioner. Lester M. Ponder, Esq., for the respondent.
1. Held: Petitioner has not shown that its average base period net income but for a strike would have resulted in an excess profits credit greater than that computed on the basis of invested capital which was allowed by respondent.
2. Held: The tax computed without the benefit of section 722(b)(1), I.R.C., is not shown to be excessive and discriminatory. Carl Tangeman, Esq., and John C. Elam, Esq., for the petitioner. Lester M. Ponder, Esq., for the respondent.
The respondent disallowed petitioner's application for relief under section 722(b)(1) of the Internal Revenue Code for the fiscal years ending June 30, 1941, June 30, 1942, and June 30, 1943. The sole issue is whether the respondent erred in such action.
FINDINGS OF FACT.
The facts stipulated are so found.
The D. L. Auld Company, the petitioner, was incorporated in Ohio in 1906, and has its principal place of business in Columbus, Ohio. The petitioner corporation reports its income for Federal taxes on the accrual basis of accounting for a fiscal year ending June 30. The income and excess profits tax returns for the years ended June 30, 1941, 1942, and 1943 were filed with the collector of internal revenue for the eleventh district of Ohio.
Petitioner has engaged in the manufacture of metal trim for the automotive and appliance industries since 1912. Hub caps, name plates, fender trim and ornaments were among the products made. Approximately 80 per cent of the petitioner's business was with the automobile industry and, prior to 1936, the corporation had sold to all of the major automobile producers and was a leader in its field. The automobile manufacturers usually relied upon one source of supply for a particular part of the cost of the tools required in the production of these parts.
In its process of manufacture, the petitioner used dies in stamping and embossing operations. Separate dies were required for each individual piece and for each operation. A great deal of the process requires handwork. The dies used by the petitioner were made by the petitioner, part of the cost being paid by the customers. The dies remained with the petitioner corporation unless the customer wished to remove them, in which case the customer was required to pay the full price of the dies if the petitioner had not been at fault. Prior to 1936 no automobile manufacturer had sought to remove its dies from the petitioner's plant. Despite the fact that most of the automobile manufacturers brought out new models each year the tools and dies used in making hub caps and trim were not always changed.
Prior to October 19, 1936, the petitioner had not recognized any labor organization as the bargaining representative of its employees, numbering over 400. On that date an organizational strike was begun in Columbus by a representative of the C.I.O. The petitioner's plant closed down and production stopped. A picket line was formed and all workers were kept out of the plant. The strike did not gain great favor and after 200 employees agreed to return to work the corporation set the date for opening the plant. The Auld plant reopened on November 12, 1936. Not all of the employees returned to work and the picket line continued around the plant until the middle of December 1936. The union was not successful in its effort for recognition and no labor organization was recognized by the petitioner prior to June 30, 1940. By February 1937, the number of employees on the payroll had increased to more than 400. The average number of workers remained over 300 in 1937. In 1938 the number declined but rose again in 1939 and 1940.
Upon notification of the existence of the strike at petitioner's plant, automotive customers of petitioner sent representatives to Columbus to take their dies and tools out of the plant. Prior to 1936 the petitioner had never failed to meet their customer's schedules. The dies which were made for petitioner's presses were reworked to fit the press equipment of petitioner's competitors. During the period 1936-1939 there was an increase in strike activity in the automotive industry which underwent a general process of unionization during these years.
The petitioner's excess profits credits were computed under the invested capital method in its returns for the fiscal years ending June 30, 1941, 1942, and 1943 because this method of computation resulted in a lesser tax. The excess profits credits computed by this method were $38,902.10, $46,550.44, and $45,633.21 for the fiscal years ending in 1941, 1942, and 1943, respectively. In September 1943 and August 1944 the petitioner applied for relief under section 722, I.R.C. In its applications the petitioner sought refunds of excess profits taxes in the amounts of $2,181.78, $27,054.25, and $61,250.26 for the fiscal years ending in June 1941, 1942, and 1943. A supplement to the applications was filed in April 1946. On June 9, 1948, the respondent disallowed the petitioner' applications for relief and determined the deficiencies. The excess profits taxes determined by the respondent were $8,582.58, $27,830.06, and $83,676.92 for the years ending in June 1941, 1942, and 1943, respectively.
During the fiscal years ending June 30 of 1937, 1938, 1939, and 1940 the petitioner's net sales, gross profits and taxable net income were as follows:
+---+ ¦¦¦¦¦ +---+
Taxable net Year Net sales Gross profit income (or loss) 6/30/37 $793,591.17 $38,864.28 ($123,538.06) 6/30/38 679,885.32 54,554.85 (86,469.57) 6/30/39 619,879.02 94,943.50 (19,332.27) 6/30/40 1,176,768.39 168,509.31 (5,144.33)
The petitioner's net sales, gross profits and taxable net income for the 16 years prior to the fiscal year ending in 1937 are represented by the following figures:
+---+ ¦¦¦¦¦ +---+
Taxable net Year Net sales Gross profit income or loss) 6/30/21 $739,959.99 $316,927.09 $19,559.80 6/30/22 823,739.52 376,184.28 57,101.16 6/30/23 1,223,562.27 456,742.52 100,002.35 6/30/24 764,801.10 200,765.78 34,326.07 6/30/25 932,344.53 393,874.90 56,843.07 6/30/26 1,384,135.18 587,639.50 266,639.01 6/30/27 1,246,998.75 425,970.48 167,874.77 6/30/28 1,125,435.93 346,483.04 148,699.12 6/30/29 1,631,237.30 513,942.70 240,612.91 6/30/30 1,037,044.50 243,550.05 44,410.39 6/30/31 1,027,163.67 243,931.51 41,360.45 6/30/32 679,644.96 99,795.43 (29,421.86) 6/30/33 460,313.65 71,763.92 (52,812.35) 6/30/34 920,588.52 129,932.79 (29,417.20) 6/30/35 837,807.52 140,556.50 7,146.78 6/30/36 1,323,664.50 184,179.41 6,019.30
It was the custom of the automotive industry to bring out a new model each year. Contracts were let during the summer months. Production of parts would start in July and continue through September and October. New models would be put forth to the public from November to January. The production of automobiles for the model years 1936 through 1940, was as follows:
+----+ ¦¦¦¦¦¦ +----+
Chrysler Ford Motor General Total of all Model Year Corporation Co. Motors manufacturers 1936 1,006,081 1,115,898 1,874,348 4,498,641 1937 1,126,230 1,282,803 1,908,821 5,013,867 1938 608,660 617,046 1,154,956 2,761,402 1939 838,170 760,615 1,407,070 3,390,382 1940 870,175 925,961 1,843,733 4,182,143
The petitioner's cash receipts from various customers for the same years are as follows:
+-----------------------------------------------------------+ ¦ ¦Chrysler ¦Ford Motor¦General ¦Total of all ¦ +----------+-----------+----------+-----------+-------------¦ ¦Model year¦Corporation¦Co. ¦Motors ¦manufacturers¦ +----------+-----------+----------+-----------+-------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------+-----------+----------+-----------+-------------¦ ¦1936 ¦$112,445.93¦$26,399.64¦$399,716.45¦$1,053,793.26¦ +----------+-----------+----------+-----------+-------------¦ ¦1937 ¦103,287.37 ¦33,652.79 ¦59,314.98 ¦476,867.74 ¦ +----------+-----------+----------+-----------+-------------¦ ¦1938 ¦76,367.17 ¦25,770.21 ¦60,830.54 ¦488,000.83 ¦ +----------+-----------+----------+-----------+-------------¦ ¦1939 ¦85,631.05 ¦20,998.12 ¦73,667.51 ¦476,431.83 ¦ +----------+-----------+----------+-----------+-------------¦ ¦1940 ¦304,575.74 ¦2,259.84 ¦100,476.57 ¦932,052.05 ¦ +----------+-----------+----------+-----------+-------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------+
The petitioner's excess profits net income (or loss) for the fiscal years 1936 through 1939, was as follows:
+---------------------------+ ¦Year ended ¦Amount ¦ +------------+--------------¦ ¦ ¦ ¦ +------------+--------------¦ ¦6/30/37 ¦($123,813.88) ¦ +------------+--------------¦ ¦6/30/38 ¦(86,469.57) ¦ +------------+--------------¦ ¦6/30/39 ¦(19,332.27) ¦ +------------+--------------¦ ¦6/30/40 ¦(466.70) ¦ +---------------------------+
The petitioner's total assets, notes payable, accumulated earnings and dividends paid for the taxable years ending June 30, 1930 through June 30, 1940, were as follows:
+----+ ¦¦¦¦¦¦ +----+
Total assets Year ended (less reserve for Notes Accumulated Dividends depreciation) payable earnings paid (cash) 6/30/30 $979,451.28 0 $648,036.44 $49,518 6/30/31 984,765.83 0 665,687.48 22,010 6/30/32 942,753.13 $25,000.00 624,126.87 16,512 6/30/33 941,776.60 96,000.00 530,336.07 31,944 6/30/34 926,977.20 115,993.13 494,552.02 7,983 6/30/35 746,736.50 70,000.00 352,418.01 0 6/30/36 733,564.51 30,000.00 364,436.94 0 6/30/37 703,782.81 150,000.00 228,026.28 5,322 6/30/38 557,303.49 129,913.90 140,308.62 0 6/30/39 565,777.14 128,799.45 114,374.60 0 6/30/40 497,779.54 145,825.42 119,822.81 0
During the years 1936-1940 the petitioner corporation was engaged in competition with a number of corporations, two of which had become subsidiaries of General Motors Corporation. Prior to the strike in October 1936, the vice president of the corporation stated at an annual stockholders meeting held in August of that year that competition had forced down the selling price of hub caps, which constituted approximately 50 per cent of the petitioner's total volume, with the result that the petitioner was securing very little business in that field. The ultimate result expected was a smaller volume of business for the coming year.
At the board of directors meeting held in June 1937, the same officer reported that the Company had received the Studebaker hub cap contracts for the coming year. In January of 1938 the vice president reported that sales had declined with a slump in general business. In May 1938 the vice president reported that the low sales volume would continue while customers' operations were reduced and suspended. At the annual stockholders meeting in August 1938, the vice president stated that no many contracts had been secured because of very low prices at which competitors took new business. At the board of directors meeting in August 1939, the vice president announced that the coming year's business should show an increase of 50 per cent over the past year's sales. In August of 1940, at the annual stockholders meeting, the treasurer reported that sales during the past year nearly doubled the preceding year. It was explained that the small profit was due to the fact that the large increase in volume necessitated the training of new help and the running of second shifts.
VAN FOSSAN, Judge:
The only issue present in this proceeding is whether or not the petitioner is entitled to excess profits tax relief under section 722(b)(1) of the Internal Revenue Code. The petitioner corporation sustained a loss in each of the fiscal years ending in June of 1937, 1938, 1939, and 1940 which constitute the statutory base period. The average base period net income being zero, the corporation, which had existed since 1906, elected to compute its excess profits credit based on invested capital. The excess profits credits so computed were $38,902.10, $46,550.44, and $45,633.21 for the fiscal year ending on June 30, 1941, 1942, and 1943, respectively. It is petitioner's contention that the excess profits tax computed without the benefit of section 722(b)(1) is excessive and discriminatory. To qualify under section 722(b)(1) the petitioner must demonstrate that because of the strike in October 1936 the average base period net income is an inadequate standard of normal earnings. Monarch Cap Screw & Manufacturing Co., 5 T.C. 1220. The average base period net income, however, was not the standard used by the petitioner in determining the excess profits credits and the excess profits tax. As stated above, the invested capital method was employed. In these circumstances the petitioner must, therefore, show, not only that a strike occurred which interrupted or diminished normal production, output or operation in one or more taxable years in the base period, but also that the constructive average base period net income which would have been normal in the absence of the strike will result in an excess profits credit greater than that computed on the basis of invested capital and allowed by the respondent. Monarch Manufacturing Co., 15 T.C. 442. It is to be noted that section 722(b)(1) is concerned with an unusual event interrupting or diminishing production, output or operation. The language of the statute does not refer to an event which only affects the profit-making ability of the corporation without affecting production.
SEC. 722. GENERAL RELIEF— CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.(a) GENERAL RULE.— In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon a comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. In determining such constructive average base period net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, except that, in cases described in the last sentence of section 722(b)(4) and in section 722(c), regard shall be had to the change in the character of the business under section 722(b)(4) or the nature of the taxpayer and the character of its business under section 722(c) to the extent necessary to establish the normal earning to be used as the constructive average base period net income.(b) TAXPAYERS USING AVERAGE EARNINGS METHOD.— The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because—(1) in one or more taxable years in the base period normal production, output, or operation was interrupted or diminished because of the occurrence, either immediately prior to, or during the base period, of events unusual and peculiar in the experience of such taxpayer.
SEC. 713. EXCESS PROFITS CREDIT— BASED ON INCOME.(b) BASE PERIOD.—(1) DEFINITION.— As used in this section the term ‘base period.‘—(A) If the corporation was in existence during the whole of the forty-eight months preceding the beginning of its first taxable year under this subchapter, means the period commencing with the beginning of its first taxable year beginning after December 31, 1935, and ending with the close of its last taxable year beginning before January 1, 1940; and
SEC. 712. EXCESS PROFITS CREDIT— ALLOWANCE.(a) DOMESTIC CORPORATIONS.— In the case of a domestic corporation which was in existence before January 1, 1940, the excess profits credit for any taxable year shall be an amount computed under section 713 or section 714, whichever amount results in the lesser tax under this subchapter for the taxable year for which the tax under this subchapter is being computed. In the case of all other domestic corporations the excess profits credit for any taxable year shall be an amount computed under section 714. * * *SEC. 714. EXCESS PROFITS CREDIT— BASED ON INVESTED CAPITAL.The excess profits credit, for any taxable year, computed under this section, shall be the amount shown in the following table:
The strike at the petitioner's plant occurred on October 19, 1936, within the first six months of the statutory base period. It closed the plant until November 12 of that year. The strike ended in December of the same year. The interruption of production during this short period does not automatically dictate a holding that the average base period net income which would have been earned if there had been no strike would have resulted in a greater excess profits credit than that computed on the invested capital basis.
It is the petitioner's contention that the loss of tools and dies to its competitors, the loss of trained personnel, the loss of contracts and orders with customers who feared a recurrence of the strike caused the excess profits tax to be excessive and discriminatory. The petitioner argues that the effects of the strike were sufficiently strong and enduring to decrease the average base period net income to such an extent that the excess profits credits computed by the invested capital method would be less than the excess profits credits based on the average base period net income that would have been earned had there been no strike.
The evidence shows that when the strike occurred at the Auld plant, the petitioner's automotive customers took the dies necessary to produce their parts and had them reworked to fit other equipment. The loss of these tools prevented the petitioner from continuing its production of parts for the 1937 model automobiles. There is no evidence in the record before us, however, showing the petitioner's production, operation, or output in terms of units before or after the strike. We must, therefore, employ other data to determine the effect of the strike on production.
At the time of the strike petitioner employed approximately 400 persons. In November of 1936, before the strike was called off, over 200 employees returned to work. In February of 1937 the full complement of over 400 employees was at work. Though some of these workers may have been newly employed, untrained personnel, the figures approximate the number of employees at work prior to the strike. Throughout the remainder of 1937 an average of more than 300 employees was carried on the payroll. The number of workers declined in 1938 but increased again in 1939 and 1940. Examination of these data does not indicate a serious interruption or diminution of production or operation because of the 1936 strike.
The production of trim parts and hub caps is partially reflected in net sales figures because the constantly changing automobile and appliance designs require the majority of such parts to be sold while still in style. Some parts are, of course, used as replacements. Net sales of the Auld Company indicate that the years 1926 through 1931 were relatively the strongest in terms of sales in petitioner's experience but that sales declined sharply in 1932 and continued at a lower level through 1935. In 1936 sales increased again but dropped off during the next three years. In 1940 net sales again rose to the level of the 1926-1931 period. Production and net sales decreased in the base period years ending in June 1937, 1938, and 1939, and attained a high level again in the year ending June 1940. Since we are concerned with the average base period net income that the petitioner would have received had there been no strike, we must examine this decline in production and sales against the background of automobile production which was the source of 80 per cent of the petitioner's business.
During the first year of the base period, mid-1936 to mid-1937, the petitioner's net sales and cash receipts from automotive customers decreased by more than $500,000 from the prior year, whereas automobile production for the model year 1937 increased by over 500,000 cars. It was in this period that the strike occurred. During the following year net sales dropped only $113,706 and cash receipts from automotive customers increased by more than $11,000. Automobile production, however, was down almost half of the total for the previous year. In fiscal 1939 net sales decreased slightly as did cash receipts for the model year. At the same time, automobile production began to climb upwards. By mid-1940, automobile production had increased by approximately 700,000 cars. Petitioner's net sales increased by more than $500,000 and cash receipts from automobile manufacturers went up almost $500,000 over the previous year.
It can be seen from these figures that the petitioner suffered a sharp decline in production and sales in the fiscal year ending in 1937. It will not be gainsaid that this year was seriously affected by the strike and it can be accurately said that the strike interrupted and diminished the production and operation of the corporation in that year. The fact that a cash dividend was declared during the year ending in 1937 is not particularly persuasive of a different conclusion. In the fiscal year ending in 1938, however, automobile production decreased by almost half of the previous year's total. At the same time petitioner's cash receipts from automotive customers increased. It thus appears that whatever the effect of the strike in the year 1936-1937 little effect was felt in 1937-1938.
During the next two fiscal and model years the petitioner's net sales and cash receipts followed the general trend of automobile production and by the close of June 1940 the petitioner had secured a net sales and cash receipts position approximately equal to that of fiscal 1936. Automobile production for 1939-1940 had similarly nearly attained the 1936 level. It becomes apparent from this examination that the effects of the strike were felt during one fiscal year but that corporate production and operation thereafter attained a level which can only be called normal under the circumstances. The effects of the strike were not strong enough to affect seriously petitioner's production or operation in the years after June 1937.
A similar conclusion is reached when the statements of petitioner's officers at stockholders and directors meetings during the period in question are examined. Before the strike it was noted that the Auld Company was securing very little hub cap business which had previously accounted for 50 per cent of the petitioner's volume. In 1938 a general slump in business was noted. This observation tallies with the examination of automobile production for that year. Also, in 1938 the corporate officers were told that low sales would continue while customers maintained reduced or suspended operations. Competition, with very low prices, was blamed for taking away business. In 1939 and 1940 the corporate officers reported increased sales but no corresponding increase in profit. These reports coincide with the facts revealed by the data on net sales, cash receipts and automobile production.
The figures on gross profits, taxable net income and excess profits income indicate that the losses sustained during the base period years were reduced in each year of that period. The decline in total assets and accumulated earnings and the increase in notes payable evidence an unsatisfactory financial condition during the base period, but there is no proof that this situation resulted from the strike of October 1936. Income, asset, and profit figures reflect other elements besides corporate production and operation, and the loss of profits may well have been due to factors such as competition and decreased automobile production which are not within the scope of section 722(b)(1). Harlan Bourbon & Wine Co., 14 T.C. 97. One fact that may have affected petitioner's production was the acquisition by General Motors of subsidiaries to produce hub caps and trim parts. The ownership of a plant to make these parts would reduce this automotive manufacturer's demand for the petitioner's products.
We conclude that section 722(b)(1) is unavailable. We so conclude because the petitioner has failed to sustain its burden of showing that, because of the existence of the brief interruption and diminution, the excess profits credit computed and allowed on the basis of invested capital was inadequate. The effects in the later years of the strike were not sufficiently evidenced to lead us to the conclusion that the corporation would have attained a higher excess profits credit based upon the average base period net income reconstructed as if no strike had occurred. Albeit any computation under section 722 must be based on assumptions, such assumptions must comport with reason when associated with known facts.
Reviewed by the Special Division.
Decision will be entered for the respondent.