Opinion
Docket No. 4636-66.
1968-05-20
FABER CEMENT BLOCK CO., INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Samuel J. Foosaner, for the petitioner. Gerald Backer, for the respondent.
Samuel J. Foosaner, for the petitioner. Gerald Backer, for the respondent.
Petitioner's liquid assets were fully committed to the reasonable needs of its business, as reflected in sufficiently definite plans for expansion and working capital requirements, to justify the retention of its entire accumulation of earnings and profits during 1961, 1962, and 1963. Consequently, petitioner was not liable for the surtax imposed by sec. 531, I.R.C. 1954.
TANNENWALD, Judge:
Respondent determined deficiencies in accumulated earnings taxes for the taxable years 1961, 1962, and 1963 in the respective amounts of $50,928.91, $34,317.22, and $55,824.07. The sole question for our consideration is whether petitioner was availed of for the purpose of avoiding Federal income taxes with respect to its shareholders.
FINDINGS OF FACT
Some of the facts have been stipulated. Those facts and the exhibits attached thereto are hereby incorporated by this reference.
Petitioner, Faber Cement Block Co., Inc. (hereinafter referred to as Faber Block), is a New Jersey corporation engaged in the business of manufacturing and selling cement and cinder blocks. It had its principal place of business at the time the petition herein was filed at Paramus, N.J. Petitioner's books and tax returns are kept and filed on the calendar year, accrual basis. Timely Federal corporate income tax returns were filed for 1961, 1962, and 1963 with the district director of internal revenue, Newark, N.J.
Beginning sometime around 1920, Albert J. Faber and Gerhardt P. Faber operated the business as a partnership with their father. In 1928, the partnership was incorporated. Since 1938, Faber Block has been located on Route 17, Paramus, N.J., approximately a mile and a half from its location prior to that time.
At all times material herein, Gerhardt P. Faber was petitioner's president, his wife, Elsie, vice president, and Albert J. Faber, secretary-treasurer, the latter being the chief administrative officer of the company. These three parties also made up petitioner's board of directors. Board meetings were sometimes attended by Emil M. Wulster and Samuel J. Foosaner, respectively, general and special tax counsel to petitioner before and during the years in issue. Foosaner prepared certain corporate minutes for board meetings held during such years.
Prior to 1958, the outstanding stock of Faber Block was held as follows:
+---------------------------------------+ ¦ ¦Number of ¦ ¦ +-----------------+-----------+---------¦ ¦Stockholder ¦shares ¦Percent ¦ +-----------------+-----------+---------¦ ¦ ¦ ¦ ¦ +-----------------+-----------+---------¦ ¦Albert J. Faber ¦52.5 ¦50 ¦ +-----------------+-----------+---------¦ ¦Gerhardt P. Faber¦35 ¦33 1/3 ¦ +-----------------+-----------+---------¦ ¦Elsie Faber ¦17.5 ¦16 2/3 ¦ +---------------------------------------+
In 1958, a recapitalization of Faber Block was effected, resulting in three classes of authorized stock, as follows: 1,000 shares $100 par 6 percent cumulative preferred stock; 5,000 shares no-par class A common stock (voting); 4,000 shares no-par class B common stock (non-voting). Under the new plan, voting privileges were vested exclusively in the class A stockholders. Preferred shareholders were to have preference upon liquidation to the extent of the par value of the stock plus any unpaid dividends. Thereafter, class A and class B shareholders would share ratably in the distribution. After payment of a 6-percent dividend on a cumulative basis to preferred shareholders, class A and class B holders were to be entitled on an equal basis to such dividends as the board of directors might declare. Pursuant to such plan, each share of old stock was exchanged for 10 shares of class A and 20 shares of class B. No preferred stock was ever issued. Immediately following the recapitalization, the issued and outstanding stock of petitioner stood as follows:
+--------------------------------------------------------+ ¦ ¦Class A ¦Class B ¦ +-----------------+-----------------+--------------------¦ ¦ ¦common (voting) ¦common (nonvoting) ¦ +-----------------+-----------------+--------------------¦ ¦Stockholder ¦shares ¦shares ¦ +-----------------+-----------------+--------------------¦ ¦ ¦ ¦ ¦ +-----------------+-----------------+--------------------¦ ¦Albert J. Faber ¦525 ¦1,500 ¦ +-----------------+-----------------+--------------------¦ ¦Gerhardt P. Faber¦350 ¦700 ¦ +-----------------+-----------------+--------------------¦ ¦Elsie Faber ¦175 ¦350 ¦ +-----------------+-----------------+--------------------¦ ¦ ¦1,050 ¦2,100 ¦ +--------------------------------------------------------+
At the stated dates during the years in issue, the outstanding class B stock was held by the following individuals in the following amounts:
+-----------------------------------------------------------------------------+ ¦ ¦Dec. 1, ¦Dec. 24, ¦ +---------------------------------------------------+------------+------------¦ ¦Individuals 1 ¦[FNi1961 ] ¦[FN 1962 ] ¦ +---------------------------------------------------+------------+------------¦ ¦ ¦ ¦ ¦ +---------------------------------------------------+------------+------------¦ ¦Gerhardt P. Faber ¦520 ¦490 ¦ +---------------------------------------------------+------------+------------¦ ¦Elsie Faber ¦350 ¦365 ¦ +---------------------------------------------------+------------+------------¦ ¦Alan Faber ¦180 ¦195 ¦ +---------------------------------------------------+------------+------------¦ ¦Albert J. Faber ¦330 ¦195 ¦ +---------------------------------------------------+------------+------------¦ ¦Jesse Douglas ¦72 ¦87 ¦ +---------------------------------------------------+------------+------------¦ ¦Marilyn G. Douglas ¦72 ¦87 ¦ +---------------------------------------------------+------------+------------¦ ¦Jesse and Marilyn Douglas in trust for Calvin ¦72 ¦87 ¦ ¦Douglas ¦ ¦ ¦ +---------------------------------------------------+------------+------------¦ ¦Jesse and Marilyn Douglas in trust for Dana Lynn ¦ ¦ ¦ +---------------------------------------------------+------------+------------¦ ¦Douglas ¦72 ¦87 ¦ +---------------------------------------------------+------------+------------¦ ¦Jesse and Marilyn Douglas in trust for Debra Ann ¦ ¦ ¦ +---------------------------------------------------+------------+------------¦ ¦Douglas ¦72 ¦87 ¦ +---------------------------------------------------+------------+------------¦ ¦Doris Farrell ¦72 ¦87 ¦ +---------------------------------------------------+------------+------------¦ ¦Christopher W. Farrell ¦72 ¦87 ¦ +---------------------------------------------------+------------+------------¦ ¦Christopher W. and Doris Farrell in trust for ¦ ¦ ¦ ¦Stephen ¦ ¦ ¦ +---------------------------------------------------+------------+------------¦ ¦Farrell ¦108 ¦123 ¦ +---------------------------------------------------+------------+------------¦ ¦Christopher W. and Doris Farell in trust for Donald¦ ¦ ¦ +---------------------------------------------------+------------+------------¦ ¦Farrell ¦108 ¦123 ¦ +---------------------------------------------------+------------+------------¦ ¦Total class B stock outstanding ¦2,100 ¦2,100 ¦ +-----------------------------------------------------------------------------+
The Faber brothers had started in the cement and cinder block business on a part-time basis with very limited facilities. The business prospered, but, until late 1957, petitioner operated with hand machinery and increasingly inadequate facilities. Moreover, its equipment over the years, including the taxable periods involved herein, had been subjected to heavy use. In 1957, Faber Block opened expanded facilities at the same location in Paramus in order to meet the increasing demand for its products and to provide safer working conditions for its employees. Prior to such expansion, petitioner had been required to, and did, obtain a variance from the Paramus Zoning Board because of a local ordinance passed in 1956 which prohibited cement and cinder block manufacture, thus constituting petitioner's plant a nonconforming use.
Faber Block did a substantial amount of business in Rockland County, N.Y. In 1957, it decided to build a plant in Monsey, N.Y. Initially, the cost of such plant was estimated at approximately $500,000. Construction was commenced in 1959 and completed in 1960 at an approximate total cost of $450,000. Such construction was financed in part by an $85,000 mortgage, the entire amount of which was paid off within 2 years.
Beginning in 1961 and throughout the years in issue, plans for further expansion were discussed by the officers and directors of petitioner. The minutes of a board meeting held March 1, 1961, read:
Mr. Albert J. Faber stated, at the outset of the meeting, that the Company's expansion needs were such that consideration should be given to other possible sites on Route 17 for plant facilities if neighbors objections or other problems prevented new construction on the present site of the Company. The other Directors were in agreement with this thought and it was concluded that such investigation should be conducted.
The results of such ‘investigation’ were enunciated in the minutes of a December 14, 1961, board meeting, where Albert Faber reported that he could find no property on Route 17 adequate to serve petitioner's needs unless it was willing to spend in excess of $400,000 for such land. The directors thereupon resolved to ‘make a further study of the possibility of expanding its plant facilities in either Monsey, N.Y., or Paramus, N.J., or in both locations, rather than seek new land at prohibitive costs at this time.’ The minutes of a board meeting on December 20, 1962, reflect further consideration of expansion plans with particular reference to the cost thereof based upon the statement of Albert Faber that ‘in his opinion, to provide the expansion of the plant facilities and the necessary new machinery and equipment could require somewhere between $500,000 and $750,000.’
The minutes of a board meeting held December 19, 1963, contained a resolution to the effect that Faber Block proceed ‘to engage such expert assistance as might be necessary to prepare plans for expanding the plant facilities in Paramus, it appearing that Paramus was the most logical location.’ Petitioner had been somewhat skeptical about expanding the existing Paramus plant, mainly because it was a non-conforming use under the local zoning ordinance and, consequently, a variance had to be secured before any expansion could be undertaken. Despite the objections and resistance displayed by neighboring residents, Albert Faber was convinced that the necessary variance could eventually be obtained. He had discussed petitioner's proposed expansion at various times since 1961 with the Mayor of Paramus, who had recommended deferring application for a variance until local opposition had toned down.
In addition to plans for expansion of petitioner's plant, there was recognition of the need to acquire more modern equipment for existing facilities, as reflected in the minutes of meetings of petitioner's board of directors as follows:
+-------------------------------------------------------------------------+ ¦Mar. 1, 1961 ¦Four trucks plus ancillary equipment--no cost stated. ¦ +-------------+-----------------------------------------------------------¦ ¦Mar. 28, 1962¦Loader, cement bin and conveyor, trucks and trailers-- ¦ +-------------+-----------------------------------------------------------¦ ¦ ¦estimated cost $85,100. ¦ +-------------+-----------------------------------------------------------¦ ¦Oct. 3, 1962 ¦Grinding machine and trucks--estimated cost $29,500. ¦ +-------------+-----------------------------------------------------------¦ ¦Dec. 19, 1963¦Review of acquisitions made during 1963 having an aggregate¦ +-------------+-----------------------------------------------------------¦ ¦ ¦cost of $130,000. ¦ +-------------------------------------------------------------------------+
Upon advice of its general course, petitioner embarked on a program of building up the commercial character of the property contiguous to the existing plantsite. It was hoped that such program would provide a ‘buffer zone’ of friendly neighbors around petitioner's plant to counteract the pressure of complaining neighbors and thus help to change the tides of local opposition to the dust and noise emanating from petitioner's operations. Pursuant to this plan, additional land was purchased and developed for commercial tenants by Faber Bros., Inc. (hereinafter referred to as Faber Bros.), a New Jersey corporation whose stock was held 50 percent by Albert Faber and 50 percent by Gerhardt and Elsie Faber. The land acquired by Faber Bros. had a large potential future increase in value. Faber Bros. also owned the land upon which petitioner's plant was located and received rent therefor from petitioner. The ‘buffer zone’ acquisitions were financed in part by interest-bearing loans from petitioner to Faber Bros. The outstanding principal balance on such loans at December 31, 1961, 1962, and 1963, was $155,000, $18,000, and $165,000, respectively. By December 31, 1966, the principal balance had been reduced to $80,000.
The following shows comparative balance sheets of Faber Bros. at December 31, 1961, 1962, and 1963 (rounded to the nearest thousand):
+--------------------------------------------------------+ ¦ ¦12/31/61¦12/31/62¦12/31/63¦ +-----------------------------+--------+--------+--------¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------+--------+--------+--------¦ ¦Cash ¦$11 ¦$34 ¦$18 ¦ +-----------------------------+--------+--------+--------¦ ¦Notes and accounts receivable¦1 ¦3 ¦8 ¦ +-----------------------------+--------+--------+--------¦ ¦Buildings ¦674 ¦786 ¦864 ¦ +-----------------------------+--------+--------+--------¦ ¦(Reserve) ¦(189) ¦(211) ¦(239) ¦ +-----------------------------+--------+--------+--------¦ ¦Land ¦86 ¦86 ¦86 ¦ +-----------------------------+--------+--------+--------¦ ¦Other assets ¦5 ¦6 ¦9 ¦ +-----------------------------+--------+--------+--------¦ ¦Total assets ¦589 ¦704 ¦746 ¦ +-----------------------------+--------------------------¦ ¦ ¦ ¦ +-----------------------------+--------------------------¦ ¦Accounts payable ¦ ¦ ¦$2 ¦ +-----------------------------+--------+--------+--------¦ ¦Federal income tax ¦$16 ¦$18 ¦22 ¦ +-----------------------------+--------+--------+--------¦ ¦Mortgages, notes, and bonds ¦297 ¦380 ¦390 ¦ +-----------------------------+--------+--------+--------¦ ¦Other liabilities ¦6 ¦11 ¦6 ¦ +-----------------------------+--------+--------+--------¦ ¦Capital stock ¦32 ¦32 ¦32 ¦ +-----------------------------+--------+--------+--------¦ ¦Earned surplus ¦238 ¦263 ¦294 ¦ +-----------------------------+--------+--------+--------¦ ¦Total liabilities ¦589 ¦704 ¦746 ¦ +--------------------------------------------------------¦ ¦ ¦ +--------------------------------------------------------+
The existence of local opposition to petitioner's facilities made it advisable for petitioner to move quietly and carefully in terms of obtaining permission of the zoning authorities for its expansion plans. In 1963, a beautification committee was formed in Paramus, the existence and operation of which helped pave the way for an easing of such opposition, since the proposed expansion would modernize and provide a better appearance and cleaner operation of petitioner's facilities on Route 17. In 1965, the local situation had clarified sufficiently, with the result that petitioner engaged architects to prepare plans for the expansion. The plans were completed in February 1966, at which time the desired variance was successfully obtained. Petitioner promptly proceeded to obtain a building permit and immediately thereafter initiated construction.
The cement and cinder block industry in the northern New Jersey area is highly competitive. Faber Block has enjoyed a most respected position in the industry. Architects on large jobs such as school construction often specified ‘Faber Cement Blocks or equal,‘ and, in cases where petitioner has been the unsuccessful bidder for a particular job, the builder awarded the contract has on occasion come to petitioner to buy the particular type of block specified.
The building and construction industry requires a great number and variety of blocks. In 1957, when petitioner's expansion program first began, its production was limited to 20 types of blocks; now over 100 different types are produced. To meet the increasing demands of its customers, petitioner has attempted to acquire and utilize modern and efficient plant facilities, machinery, and equipment, consequently spending large sums annually towards such purpose. The following indicates capital acquisitions for the 10-year period 1957 through 1966:
+-------------------------------------------------------------------------------+ ¦ ¦Total ¦Machinery and ¦ ¦ ¦ ¦ ¦ +----+------------+----------------+---------------+-------+--------------------¦ ¦Year¦acquisitions¦equipment ¦Trucks and ¦ ¦Extraordinary items ¦ ¦ ¦ ¦ ¦autos ¦ ¦ ¦ +----+------------+----------------+---------------+-------+--------------------¦ ¦ ¦ ¦ ¦ ¦ ¦(nonrecurring) ¦ +----+------------+----------------+---------------+-------+--------------------¦ ¦ ¦ ¦Paramus¦Monsey ¦Paramus¦Monsey ¦ ¦ ¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦1957¦$53,182 ¦$12,238¦ ¦$33,517¦ ¦ ¦ ¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦1958¦111,865 ¦71,379 ¦ ¦7,308 ¦ ¦$32,793¦(Bldg.—East ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦Paterson) ¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦1959¦124,379 ¦85,730 ¦ ¦33,965 ¦ ¦ ¦ ¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦1960¦433,018 ¦26,414 ¦$211,758¦11,200 ¦$30,106¦145,849¦(Plant bldg.—Monsey)¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦1961¦85,293 ¦9,819 ¦ ¦64,857 ¦ ¦ ¦ ¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦1962¦89,297 ¦26,880 ¦ ¦56,462 ¦2,760 ¦ ¦ ¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦1963¦154,345 ¦108,461¦12,462 ¦13,832 ¦10,761 ¦7,603 ¦(Plant bldg.—Monsey)¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦1964¦218,909 ¦37,356 ¦124,341 ¦38,698 ¦ ¦10,194 ¦(Plant bldg.—Monsey)¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦1965¦227,967 ¦71,752 ¦12,750 ¦95,363 ¦11,106 ¦12,498 ¦(Furn. and fix.— ¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦Paramus) ¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦1966¦370,385 ¦237,461¦6,080 ¦8,593 ¦3,195 ¦109,171¦(New—plant ¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦Paramus) ¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦ ¦1,186,610 ¦687,490¦367,391 ¦363,795¦57,928 ¦318,108¦ ¦ +----+------------+-------+--------+-------+-------+-------+--------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------------------------------------------------------------------------¦ ¦Note: The difference of $73,898 between the amount of total acquisitions and ¦ ¦the total of the other columnar amounts reflects other miscellaneous capital ¦ ¦acquisitions during the years specified. ¦ +-------------------------------------------------------------------------------+
Total capital expenditures for January through May 16 and 17, 1967 (when the trial herein took place), were approximately $295,000. As of the latter date, petitioner had expended approximately $567,000 on its Paramus expansion program, which was scheduled for completion by the end of 1967 at a total final cost of between $650,000 and $700,000.
Throughout their experience in the block business, Albert and Gerhardt Faber have striven to maintain a ‘no-borrowing’ policy, and, with limited exceptions, have managed to finance the business internally through earnings. In addition to the $85,000 mortgage secured in connection with the Monsey plant in 1960, petitioner in 1967, because of a shortage of cash, borrowed $200,000 in connection with the completion of the Paramus expansion program.
It has also been the policy of petitioner to pay its raw materials bills promptly in order to take advantage of cash discounts available upon early payment. The following reflects the date relevant to such practice during the years in issue:
+---------------------------------------------------------------------+ ¦ ¦ ¦ ¦Inventory ¦Trade accounts receivable¦ +----+----------+---------+-----------------+-------------------------¦ ¦Year¦Purchases ¦Discounts¦ ¦ ¦ +----+----------+---------+-----------------+-------------------------¦ ¦ ¦ ¦ ¦Jan. 1 ¦Dec. 31 ¦Jan. 1 ¦Dec. 31 ¦ +----+----------+---------+--------+--------+------------+------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +----+----------+---------+--------+--------+------------+------------¦ ¦1961¦$1,748,735¦$123,326 ¦$102,739¦$135,044¦NA ¦$412,534 ¦ +----+----------+---------+--------+--------+------------+------------¦ ¦1962¦1,337,171 ¦45,267 ¦135,044 ¦144,846 ¦$412,534 ¦365,546 ¦ +----+----------+---------+--------+--------+------------+------------¦ ¦1963¦1,363,587 ¦49,005 ¦144,846 ¦141,132 ¦365,546 ¦445,213 ¦ +----+----------+---------+--------+--------+------------+------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------------------------------------------------------------------+
For several years, including those in issue, petitioner has maintained for its employees a program of financial aid, pursuant to which loans (Typically non-interest-bearing) are made to help employees through difficult periods or to enable them to purchase homes. Over the years, Faber Block has enjoyed a good relationship with its labor force and has experienced only a minimal amount of turnover.
Petitioner has also found it necessary to finance some of its customers for extended periods, sometimes as long as 120 to 150 days. A substantial portion of petitioner's accounts receivable is typically over 90 days old. Loans made by petitioner to customers were reflected by outstanding notes receivable totaling $63,781.65, $78,854.62, and $86,253.87 at December 31, 1961, 1962, and 1963, respectively. On in?requent occasions, petitioner has charged interest of 3 to 3 1/2 percent on such loans.
In May 1960, following a trip to Germany by Albert Faber to investigate the cement-block truss industry, the Faber brothers and others connected with the block and building industries formed the United Filigree Trust Corp. (hereinafter referred to as United Filigree). United Filigree manufactured steel trusses which are used with cement blocks for roofing and flooring. Effective use of the truss serves to reduce the time and costs of construction. Petitioner, during the years in issue, advanced substantial sums to United Filigree, which sums appeared as ‘Loans Receivable’ on its balance sheet in the following amounts at the dates indicated:
+---------------------+ ¦December ¦ ¦ +----------+----------¦ ¦31— ¦Amount ¦ +----------+----------¦ ¦ ¦ ¦ +----------+----------¦ ¦1961 ¦$30,000.00¦ +----------+----------¦ ¦1962 ¦104,000.00¦ +----------+----------¦ ¦1963 ¦84,564.30 ¦ +---------------------+
Prior to 1966, petitioner owned no equity interest in United Filigree.
Beginning in 1959, petitioner started negotiations for the purchase of Hy-Way Cinder Block Co., Inc. (hereinafter referred to as Hy-Way Block). One James Swales, the owner of another New Jersey block company, agreed to join petitioner in the purchase of Hy-Way Block on a 50-50 basis. In late 1959, contracts for this proposed acquisition were prepared by petitioner's attorney. It was contemplated that the total purchase price would be $1 million, with $150,000 payable in cash and the remaining $850,000 payable over a period of 8 years with annual interest of 5 percent. Consummation of such agreement, however, was prevented because of internal strife between the related owners of Hy-Way Block— an uncle and his nephew. Throughout the years in issue, periodic discussions were held between the interested parties, but the uncle would not agree to sell. In 1964, the nephew began legal proceedings to force him to sell, but by this time Swales' interest in the venture had waned. Petitioner, however, did remain interested and continued negotiations in the hope that the family differences could be resolved. Counsel for Hy-Way Block last contacted petitioner with regard to the sale in 1967.
+-------------------------------------------------------------+ ¦ ¦Pretax not¦Federal ¦Earned surplus¦Dividends ¦ +----+----------+--------------+--------------+---------------¦ ¦Year¦income 1 ¦income tax 1 ¦Dec. 31 1 ¦ ¦ ¦ +----+----------+--------------+--------------+-------+-------¦ ¦ ¦ ¦ ¦ ¦Class A¦Class B¦ +----+----------+--------------+--------------+-------+-------¦ ¦1957¦$255,400 ¦$126,000 ¦$1,136,400 ¦$35,175¦ ¦ +----+----------+--------------+--------------+-------+-------¦ ¦1958¦185,000 ¦90,700 ¦1,210,000 ¦20,000 ¦ ¦ +----+----------+--------------+--------------+-------+-------¦ ¦1959¦281,200 ¦140,800 ¦1,346,400 ¦ ¦$10,500¦ +----+----------+--------------+--------------+-------+-------¦ ¦1960¦175,900 ¦86,000 ¦1,426,300 ¦ ¦10,500 ¦ +----+----------+--------------+--------------+-------+-------¦ ¦1961¦346,700 ¦174,500 ¦1,598,200 ¦ ¦10,500 ¦ +----+----------+--------------+--------------+-------+-------¦ ¦1962¦265,300 ¦127,900 ¦1,716,500 ¦ ¦10,500 ¦ +----+----------+--------------+--------------+-------+-------¦ ¦1963¦351,200 ¦167,100 ¦1,889,100 ¦ ¦10,500 ¦ +----+----------+--------------+--------------+-------+-------¦ ¦1964¦255,800 ¦107,300 ¦2,015,600 ¦5,250 ¦15,750 ¦ +----+----------+--------------+--------------+-------+-------¦ ¦1965¦348,700 ¦149,600 ¦2,197,900 ¦ ¦15,750 ¦ +----+----------+--------------+--------------+-------+-------¦ ¦1966¦362,200 ¦158,000 ¦2,385,200 ¦ ¦15,750 ¦ +-------------------------------------------------------------+
1 Rounded to the nearest hundred.
Prior to 1957, no dividends were paid by the petitioner.
Comparative abbreviated balance sheets and income statements per petitioner's books (in thousands of dollars) for the years in issue were as follows:
+-----------------------------------------------------------------------------+ ¦Balance Sheets at December 31— ¦ +-----------------------------------------------------------------------------¦ ¦ ¦1961 ¦ ¦1962 ¦ ¦1963 ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Cash ¦$219.2 ¦ ¦$300.6 ¦ ¦$319.6 ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Trade accounts receivable ¦412.5 ¦ ¦365.5 ¦ ¦445.2 ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Notes receivable ¦63.8 ¦ ¦78.8 ¦ ¦86.3 ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Loans receivable ¦190.3 ¦ ¦294.7 ¦ ¦264.2 ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦U.S. Treasury notes ¦65.2 ¦ ¦ ¦ ¦75.8 ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Inventories ¦135.0 ¦ ¦144.8 ¦ ¦141.1 ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Other current assets ¦27.3 ¦ ¦15.8 ¦ ¦19.5 ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Total current assets ¦1,113.3 ¦ ¦1,200.2¦ ¦1,351.7¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Cash surrender value life ¦11.6 ¦ ¦12.4 ¦ ¦13.2 ¦ ¦insurance ¦ ¦ ¦ ¦ ¦ ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Mortgages receivable ¦23.9 ¦ ¦25.4 ¦ ¦25.9 ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Fixed assets ¦$1,580.2 ¦$1,639.1¦ ¦$1,730.6¦ ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Accumulated depreciation ¦(794.9) ¦(897.4) ¦741.7 ¦(975.5) ¦755.1 ¦ ¦ ¦785.3 ¦ ¦ ¦ ¦ ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Total assets ¦1,934.1 ¦ ¦1,979.7¦ ¦2,145.9¦ +-------------------------------+---------------------------------------------¦ ¦ ¦ ¦ +-------------------------------+---------------------------------------------¦ ¦Current liabilities ¦325.4 ¦ ¦252.8 ¦ ¦246.3 ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Capital stock ¦10.5 ¦ ¦10.5 ¦ ¦10.5 ¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Earned surplus ¦1,598.2 ¦ ¦1,716.4¦ ¦1,889.1¦ +-------------------------------+-----------+--------+-------+--------+-------¦ ¦Total liabilities and capital ¦1,934.1 ¦ ¦1,979.7¦ ¦2,145.9¦ +-------------------------------+---------------------------------------------¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
+-------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦ +-------------------------------------------------------------¦ ¦Income statements ¦ +-------------------------------------------------------------¦ ¦ ¦1961 ¦1962 ¦1963 ¦ +----------------------------------+--------+--------+--------¦ ¦Net sales ¦$3,048.3¦$2,707.7¦$2,933.5¦ +----------------------------------+--------+--------+--------¦ ¦Cost of sales ¦2,570.8 ¦2,214.5 ¦2,339.4 ¦ +----------------------------------+--------+--------+--------¦ ¦Gross profit ¦477.5 ¦493.2 ¦594.1 ¦ +----------------------------------+--------+--------+--------¦ ¦General and administrative expense¦272.1 ¦293.7 ¦312.9 ¦ +----------------------------------+--------+--------+--------¦ ¦Net profit--operations ¦205.4 ¦199.5 ¦281.2 ¦ +----------------------------------+--------+--------+--------¦ ¦Other income ¦140.5 ¦64.9 ¦69.0 ¦ +----------------------------------+--------+--------+--------¦ ¦Net profit--pretax ¦345.9 ¦264.4 ¦350.2 ¦ +----------------------------------+--------+--------+--------¦ ¦Provision for income tax ¦174.5 ¦127.9 ¦167.1 ¦ +----------------------------------+--------+--------+--------¦ ¦Net profit to surplus ¦171.4 ¦136.5 ¦183.1 ¦ +-------------------------------------------------------------+
Petitioner's needs for working capital were $432,000 at the end of 1961, $473,000 at the end of 1962, and $503,000 at the end of 1963. See page 331, infra.
Prior to mailing the notice of deficiency on May 27, 1966, respondent sent, by certified mail on July 8, 1965, a notification under section 534(b) of the Internal Revenue Code, informing petitioner that the proposed notice of deficiency included an amount with respect to the accumulated earnings tax imposed by section 531. Petitioner did not respond to this request within 60 days thereafter, and no response was received prior to the issuance of the statutory notice. In the statutory notice herein, respondent computed the deficiencies in accumulated earnings tax on the basis of petitioner's entire undistributed earnings and profits for the years 1961, 1962, and 1963 in the respective amounts of $160,854.22, $117,707.07, and $173,569.
Joint Federal income tax returns filed by Gerhardt and Elsie Faber for the years in issue showed net taxable income for the taxable years 1961, 1962, and 1963 of $52,751.78,.$68,206.79, and $62,386.96, respectively.
Joint Federal income tax returns filed by Albert and Marion Faber for the years in issue showed net taxable income for the taxable years 1961, 1962, and 1963 of.$37,754.69, $60,156.88, and $58,616.87, respectively.
OPINION
+----------------------------------------------------+ ¦ ¦1961 ¦1962 ¦1963 ¦ +-------------------------+--------+--------+--------¦ ¦Current assets ¦$1,101.7¦$1,200.2¦$1,351.7¦ +-------------------------+--------+--------+--------¦ ¦Cash value-life insurance¦11.6 ¦12.4 ¦13.2 ¦ +-------------------------+--------+--------+--------¦ ¦Mortgages receivable ¦23.9 ¦25.4 ¦25.9 ¦ +-------------------------+--------+--------+--------¦ ¦Total ¦1,137.2 ¦1,238.0 ¦1,390.8 ¦ +-------------------------+--------+--------+--------¦ ¦Less: Current liabilities¦325.4 ¦252.8 ¦246.3 ¦ +-------------------------+--------+--------+--------¦ ¦Total availabilities ¦811.8 ¦985.2 ¦1,144.5 ¦ +----------------------------------------------------+
Having thus determined availabilities, we now turn our attention to the offsetting reasonable needs of petitioner's business. While petitioner claimed a variety of factors as giving rise to such needs, as we view the situation, it will suffice to concentrate on only some of them:
+--------------------------------------------------------------------------+ ¦ ¦1961 ¦1962 ¦1963 ¦ +-----------------------------------------+----------+----------+----------¦ ¦Average inventory ¦$119 ¦$140 ¦$143 ¦ +-----------------------------------------+----------+----------+----------¦ ¦Cost of goods sold (less depreciation) ¦2,442 ¦2,087 ¦2,215 ¦ +-----------------------------------------+----------+----------+----------¦ ¦Inventory turnover ¦20.5 times¦14.8 times¦15.5 times¦ +-----------------------------------------+----------+----------+----------¦ ¦Operating cycle 1 ¦17.5 days ¦24.3 days ¦23.2 days ¦ +-----------------------------------------+----------+----------+----------¦ ¦Average accounts receivable ¦348 ¦389 ¦405 ¦ +-----------------------------------------+----------+----------+----------¦ ¦Net sales ¦3,048 ¦2,707 ¦2,933 ¦ +-----------------------------------------+----------+----------+----------¦ ¦Receivables turnover ¦8.8 times ¦7.5 times ¦7.2 times ¦ +-----------------------------------------+----------+----------+----------¦ ¦Operating cycle 1 ¦40.9 days ¦48.0 days ¦50.0 days ¦ +-----------------------------------------+----------+----------+----------¦ ¦Total operating cycle 1 ¦58.4 days ¦72.3 days ¦73.2 days ¦ +-----------------------------------------+----------+----------+----------¦ ¦Costs of goods sold (as above) ¦2,442 ¦2,087 ¦2,215 ¦ +-----------------------------------------+----------+----------+----------¦ ¦Other operating expenses (less bad debts)¦259 ¦277 ¦298 ¦ +-----------------------------------------+----------+----------+----------¦ ¦Total expenses ¦2,701 ¦2,364 ¦2,513 ¦ +-----------------------------------------+----------+----------+----------¦ ¦Operating cycle percent of 1 year 1 ¦16 percent¦20 percent¦20 percent¦ +-----------------------------------------+----------+----------+----------¦ ¦Working capital needs ¦$432 ¦$473 ¦$503 ¦ +--------------------------------------------------------------------------+ FN1 Based on a 360-day year.
Because its operations constituted a nonconforming use under the local zoning ordinance, petitioner was faced with practical difficulties regarding expansion at the existing site in Paramus. Such difficulties, however, were not insurmountable, as is indeed attested to by the fact that in 1957 a variance to build a new plant had been secured under the same ordinance. By proceeding patiently and by carefully timing their application for a variance, the Fabers had good reason to believe that they would ultimately secure permission again to expand. In point of fact, this is precisely what happened, for in 1966 the desired variance was granted. Admittedly, such variance might not have been granted. Yet, the mere fact that expansion plans are contingent upon the outcome of certain local political action will not result in a blanket bar of accumulations made pursuant to such plans. Cf. Sterling Distributors, Inc. v. United States, 313 F.2d 803 (C.A. 5, 1963). Taking note of the fact that local zoning matters typically abound with political nuances, we do not think it our province to second-guess the optimism of the Fabers, especially when we are not even in a position to claim the benefit o? hindsight.
Concededly, a finding that petitioner reasonably expected to secure a variance does not of itself guarantee that the expansion would in fact take place. Thus, respondent suggests that the variance obstacle was set up as a convenient smokescreen behind which petitioner could accumulate substantial earnings without ever having any fixed intention to use such accumulations when and if the smoke cleared.
Unquestionably, as respondent points out, the minutes relating to the proposed plans for expansion are flavored with tax planning; they were concededly prepared by petitioner's tax counsel and are replete with boilerplate statements which exude concern over the possible assertion of an unreasonable accumulation challenge. But the aura of tax consciousness does not destroy the fact that the minutes contain evidence of plans to expand. Contrariwise, these minutes in and of themselves will not serve to immunize petitioner. Mere words in corporate minutes, if unsupported by further evidence of actual implementation, or the likelihood thereof, will carry little weight.
+----------------------------------------------------------------------+ ¦ ¦ ¦1961 ¦ ¦1962 ¦ ¦1963 ¦ +----------------------------+----+--------+----+--------+----+--------¦ ¦Availabilities ¦ ¦$811.8 ¦ ¦$985.2 ¦ ¦$1,144.5¦ +----------------------------+----+--------+----+--------+----+--------¦ ¦Needs ¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------------------------+----+--------+----+--------+----+--------¦ ¦Working capital ¦$432¦ ¦$462¦ ¦$490¦ ¦ +----------------------------+----+--------+----+--------+----+--------¦ ¦Plant expansion ¦750 ¦ ¦750 ¦ ¦750 ¦ ¦ +----------------------------+----+--------+----+--------+----+--------¦ ¦Machinery and equipment ¦100 ¦ ¦100 ¦ ¦100 ¦ ¦ +----------------------------+----+--------+----+--------+----+--------¦ ¦Totals ¦ ¦$1,282.0¦ ¦$1,312.0¦ ¦$1,340.0¦ +----------------------------+----+--------+----+--------+----+--------¦ ¦Deficiency in availabilities¦ ¦($470.2)¦ ¦($326.8)¦ ¦($195.5)¦ +----------------------------------------------------------------------+ On the basis of the lower of the requirements according to our calculations and those of respondent.