Peterson & Pegau Baking Co. v. Commissioner

2 B.T.A. 637, 1925 BTA LEXIS 2322

• Court: United States Board of Tax Appeals
• Decided: September 28, 1925
• Docket: Docket No. 1628.
• Status: Published

Opinion

OPINION.

James:

The major portion of the record before the Board consists in an extensive examination of Peterson relative to the alleged secret process upon which the royalties as set forth in the findings of fact were predicated. The testimony convinces us that Peterson is a successful baker and that he made effective use of the new bakery and new equipment acquired in 1918 by the taxpayer. We are not convinced that he is in possession of any particular method which could be the subject of a secret process for monopolistic use by either himself or the taxpayer.

Louis J. Gregerson was offered as a witness for the taxpayer, and his testimony in respect of the origin of the contract of May 12, 1920, may be considered as at least putting forward the most favorable possible statement of the facts. Gregerson’s testimony relative to the origin of the contract is as follows:

I made out the tax returns for 1917 for the company, and also the individual stockholders, and also during the early part of 1919 I installed their cost system in the bakery there. I spent probably three or four weeks working out a cost system. That was after the installation of this new process. The officers wanted to know whether they were making money or losing money on the new process, and I figured out their cost system. They wanted to know whether they were making money or losing money by the use of the new process. The result of several weeks’ work showed that they were making a very substantial profit, over a thousand dollars a week, and probably two thousand. The question then came up what would the taxes be for the corporation at tlhe end of the year. They expected to make a very substantial profit on this new formula. I estimated the amount of tax — I cannot recall the figures now, but I believe that I estimated an income of $100,000 for 1919. The question was then raised as to whether there was any legitimate way under the law to reduce the tax liability. I explained the various ways that I knew. One of them, the first one, was to dissolve the corporation and continue the business as a partnership. Another method would be to revert to the method used by the company prior to 1917, during which prior method the individuals owned the plant, and the corporation was' paying rent for the use of the plant. There would be the other method of the individuals operating the plant and the corporation owning the plant. There would be another method of paying increased salaries, and then there was this question of royalties. I cannot recall whether I suggested that or the officers of the corporation suggested that. As to my recommendation to the company that the corporation be dissolved, and the business be continued under the partnership, that would involve a tax of about $15,000.00. The two stockholders were afraid to take that chance of paying $15,000.00 for the privilege of dissolving the corporation inasmuch as the future was uncertain. Then the matter was discussed pro and con during the year 1919 and in December of 1919 a revenue agent cheeked up the year 1918 and reduced the officers’ salaries from $26,000.00 for the two men to $20,000.00. After that had happened the officers^realized that they could not take any more salary because that would be disallowed. Whatffurther discussion was had I cannot recall now, but, shortly before May 12, 1920, X met Mr. Peterson and Mr. Pegan in the office of the attorney, Van Arsdale, and the matter was discussed there, and the attorney, Van Arsdale, drew up the contract which has been submitted here. Mr. Peterson I believe on the stand has said that I drew up the contract. He is mistaken. I was present at the time the matter was discussed in the attorney’s office. The attorney can testify to that.

As we view it, the alleged secret process had, at best, a shadowy existence in fact and was seized upon as a mere pretext for diminution of the taxpayer’s income reported as being subject to tax. The right of any taxpayer to minimize its taxes by legitimate devices is unquestioned, but this right presupposes that a basis for such device exists legitimately and in good faith.

Extensive argument was presented on the question whether, even though a process existed, the taxpayer did not in fact own it or was entitled at least to a shop license for its use since it was developed by its own officers in the ordinary course of their employment. In the view we take of the matter, it is unnecessary to determine the question.

The Commissioner at the hearing asked the Board to consider whether a penalty for fraud should be imposed by the Board independently under its general power to determine the ultimate amount of the deficiency. • This power the Board would not hesitate to exercise under circumstances in which, in its opinion, fraudulent intent was clearly proved. In the circumstances of this appeal we are convinced that Peterson, acting under improper advice, believed he was adopting a legitimate device to avoid taxes on behalf of the corporation. The Board should' not assert a peiialty upon its own motion except under circumstances of fraud clearly proven. The deficiency determined by the Commissioner will be approved, but without a penalty.

Artxndell, not participating.