Ramsey Accessories Mfg. Corp. v. Commissioner

10 T.C. 482, 1948 U.S. Tax Ct. LEXIS 238

• Court: United States Tax Court
• Decided: March 22, 1948
• Docket: Docket No. 11851
• Status: Published

Opinions

OPINION.

Murdock, Judge:

Section 721 (a) (2) (C) provides that income resulting from development of patents or processes extending over a period of more than 12 months shall be held to be a separate class of income for the purpose of that section. The petitioner contends that all of its gross income from the sale of steel rings during 1940 and 1941 was of that class. It is obvious that not all of the income from the sale of steel rings during those years can be classified as resulting from development of patents or processes in prior years, because some of those profits must be attributed to other factors, which might include management and salesmanship, good will, and the use of physical assets. Producers Crop Improvement Association, 7 T. C. 562; W. B. Davis & Son, Inc., 5 T. C. 1195, 1215 et seq.; Eitel-McCullough, Inc., 9 T. C. 1132; Regulations 109, sec. 30.721-8 (as amended). As a matter of fact, the items necessary to reduce gross sales to gross income in the case of steel rings are not segregated on the books of the petitioner. The petitioner points out that its books were “not kept with prophetic vision as to the future requirements of income tax legislation” (Rochester Button Co., 7 T. C. 529) and attempts to overcome that deficiency by assuming that the cost of goqd's sold and the discounts, rebates, returns, replacements, and allowances applicable to sales of steel rings bear the same relation to the total of those items as sales of steel rings bear to total sales of all goods. It advocates the use of that method as the best available, at least until the Commissioner suggests a better.

The petitioner next contends that the excess of its gross income from the sale of steel rings during the taxable years over 125 per cent of the average amount of its gross income from the same source during the base years represents abnormal income. The figures for gross income arrived at by the petitioner are $907,698.05 for 1940 and $1,491,719.10 for 1941, and the abnormal income figures are $694,324.67 for 1940 and $994,690.08 for 1941. The parties have stipulated the expenses applicable to steel rings which are deductible in computing normal tax net income for each of the tax years. The petitioner deducts proper portions of those amounts, in the way described in section 721 (a) (3), from its abnormal income figures just mentioned to arrive at what it regards as net abnormal income of this class for each of the taxable years. The figures which it arrives at for net abnormal income are $131,821.06 for 1940 and $377,122.30 for 1941. It concedes that a portion of those amounts should be attributed to the general improvement or increase in sales of steel rings throughout the industry. It uses some stipulated figures compiled by a pool of piston ring manufacturers to determine how much of the net abnormal income should be attributed to that improvement and concludes that the remainders of $106,307.30 for 1940 and $256,545.78 for 1941 must be attributed in their entirety to the prior years during which it developed patents and processes for the manufacture of steel rings.

There is evidence to show that the assumption made by the petitioner in arriving at gross income from the sale of steel rings was too favorable to the petitioner. An unusually large number of rings other than steel rings were returned during the period 1937 to 1940, particularly during the years 1938 and 1939, so that it could not be assumed that the returns of steel rings would be as large during those years as returns of products of the business generally. Also, there is inconsistency in the figures stipulated to show the amount of returns. Furthermore, the pool figures upon which the petitioner relies to show the general increase in sales of steel rings include sales of “other rings” which were rapidly passing out of use, with the net result that the larger increase in sales of steel rings which would otherwise appear is offset by the decline in sales of “other rings.” Also, the pool figures do not include sales of steel rings to manufacturers. There are other defects in the evidence, some of which may work to the petitioner’s advantage and some to its disadvantage.

It appears nevertheless that the petitioner had some class (C) net abnormal income for each of the taxable years which properly should be attributed to the prior years during which the development of the patents and processes for manufacturing the steel rings occurred. Congress indicated that these relief provisions should be applied sympathetically. This petitioner should not be borne down upon too heavily because of the absence of better proof, especially where it does not appear that better proof is readily available. Cf. Cohan v. Commissioner, 39 Fed. (2d) 540. This does not mean, of course, that the petitioner should be given everything it asks for or that every doubt should be resolved in its favor.

The respondent is justified in contending that a part of the income from the sale of steel rings during each taxable year must be attributed to factors other than the development of the patents and processes and is not properly a part of class (C) income. The petitioner is under a misapprehension in arguing that the 25 per cent increase which is excluded from abnormal income takes care of all of the increases due to various other factors such as management, salesmanship, good will, and the use of physical assets. Income attributable to other factors, as stated above, is never a part of class (C) income. Furthermore, there is no reason to assume that the increase in income due to those factors is limited to 25 per cent or that the increase attributable to development of patents and processes rides as undiluted cream on the top of the volume of increased profits. Some part of an increase in profits could properly be attributed to management even though management did not change in personnel. The petitioner has failed to make any allowance for the proven increase in plant, equipment, and capacity, and it does not recognize the acquisition of the Ford business as a factor contributing to the increase in income separate from the patents and processes.

Profits are usually due to a combination of circumstances, including the availability of a salable product, capable management and salesmanship, and an adequate plant. Any increase in sales is probably due to a combination of some or all of such factors. The evidence as a whole does not justify the petitioner’s conclusion as to the amount of the income from the sale of steel rings which should be attributed to the development of the patents and processes or as to the amount of net abnormal income which should be attributed to the years during which the patents and processes were developed. While a part of the increase in income from the sale of steel rings is undoubtedly attributable to the development of the patents and processes in prior years, nevertheless, a part must likewise be attributed to the exploitation of the newly developed product through such factors as efficient management, salesmanship, and the use of plant and equipment.

The difficulty of making the essential allocations precisely or even satisfactorily is obvious. Cf. Regulations 109, secs. 30.721-3 and 30.721-8 (as amended) and corresponding provisions of later regulations. If the only income in the class is from royalties under a patent, there is no great difficulty, because then it is all class (C) income. W. B. Davis & Son, Inc., supra. But the solution of the present case is not so simple. Also, a similar difficulty is presented in determining how much of the abnormal net income should be attributed to the years in which the patents and processes were developed and how much was due to higher prices, to the Miller patent, not developed by the petitioner, to the increasing demand for steel rings, to the acquisition of the Ford business, and other factors. Fortunately, in this case it is not necessary to make an allocation to any particular prior year because in none of those years was there any excess profits tax imposed. Allocations in the respects mentioned must be made in this case by exercising common sense and judgment in the light of the proven facts. The Court has made the allocations, reducing somewhat the petitioner’s figures all along the way. It is entirely possible that the allocation made by one person would never match that made by another. The Court, after considering all of the evidence in the case, has made ultimate findings which decide the only issue in controversy.

Reviewed by Special Division.

Decision will ~be entered under Rule 50.