Action by the Elder Manufacturing Company against the United States.
Petition dismissed.
Plaintiff paid an income and profits tax of $195,609.70 for the fiscal year ending April 30, 1920, and sues to recover $192,846.64 thereof, with interest, on the ground that the value of its inventory of merchandise on hand at the end of the taxable year was $1,867,212.15 instead of $2,492,574.81 as determined by the Commissioner of Internal Revenue. The Commissioner valued the inventory on the basis of cost, as that was lower than market on the inventory date. The Commissioner held that there was a market price for such merchandise on April 30, 1920, and that such market value was higher than cost. Plaintiff contends that there was no available evidence of the existence of a fair market for the merchandise on that date, and that the market value thereof on the nearest date, or dates, after April 30, 1920, was in January, February, and March, 1921, and that the market price on such date was lower than cost. It therefore contends that under article 1584, Regs. 45, it is entitled to an inventory valuation of $1,867,212.15 on the basis of the market prices existing in January, February, and March, 1921.
Special Findings of Fact.
1. For 1919 and 1920, as well as prior years, plaintiff kept its books on the basis of a fiscal year ended on April 30 of each year. August 14, 1920, it duly filed its income and profits tax return for the fiscal year ended April 30, 1920, and paid the tax of $193,868.05 shown to be due thereon as follows: $48,467.02, August 16 and October 14, 1920; $48,467.01, January 14, 1921; and $48,467, April 15, 1921. Subsequently the Commissioner caused an examination and audit to be made of its books and records in connection with its return for 1920, and as a result the net income was increased from $639,715.39 to $641,525.78, and the tax liability in the amount of $1,741.65. The foregoing increase in net income and consequent increase in tax liability arose out of matters not involved in the present suit. An additional assessment was made on account of the above increase in tax liability and the additional assessment was paid December 8, 1926.
2. April 13, 1925, plaintiff filed a claim for the refund of income and profits tax to the extent of $192,846.64 for the fiscal year ended April 30, 1920, and assigned as a basis therefor that its inventory at the close of such year had been improperly priced, alleging that no market existed on April 30, 1920, for the items comprising its inventory on that date, and that accordingly market prices prevailing at the earliest date thereafter should be used. It was contended that such earliest date was during the first three months of 1921 and that the market prices then prevailing were substantially lower than the cost prices used in pricing its inventory at April 30, 1920. September 19, 1926, the claim for refund was rejected.
3. During 1919, 1920, and for some years prior thereto, plaintiff was engaged in the manufacture and sale of men's shirts, overalls, athletic underwear, boys' wash-wear suits, shirts, and blouses; and as a wholesale dealer, commonly termed a "jobber," in the purchase and sale of underwear, hosiery, and knit goods for men, women, and children. In its manufacturing department it purchased raw materials in the form of cotton piece goods from manufacturers, manufacturers' selling agents, and wholesalers, and manufactured therefrom finished garments which it sold to retail dealers. In its jobbing department it bought manufactured products, such as underwear, hosiery, and knit goods, which it sold to retail dealers. At April 30, 1920, the merchandise contained in its manufacturing department consisted of cotton textile fabrics which had been finished, dyed, and printed by the persons from whom plaintiff had purchased them, and they were in the form, first, of piece goods as originally purchased from mills or cotton brokers; second, of goods in process, that is, goods cut in the form of partly completed garments; and, third, of completed garments, commonly called "finished goods." The merchandise contained in its jobbing department at the same time consisted of underwear, hosiery, and knit goods which had been purchased in the completed form for resale to retail dealers.
4. In the pricing of its inventories to be used in its returns, plaintiff was on the basis of "cost or market, whichever is lower." The total cost of the inventory at April 30, 1920, consisting of unworked material, work in process, and finished goods, and including freight, labor, overhead, and inclusive of all appropriate charges, was $2,744,347.81. Plaintiff used as a closing inventory at April 30, 1920, in its return for that year, an amount of $2,492,574.81, which represented a reduction of $251,773 from the aforementioned cost figure on account of what was termed "shrinkage." By "shrinkage" was meant a reduction below cost of raw materials, goods in process, and finished goods, on account of goods purchased from a certain manufacturer. Similar goods in the inventory purchased from other manufacturers were not similarly reduced. Further, under the term "shrinkage" were included reductions below cost of certain silk materials or items made in part of silk. In the examination of plaintiff's return (referred to in finding 1), the Commissioner made no change in the inventory as set out in the return.
5. (a) From 1914 to the Armistice in November, 1918, there was a marked increase in the market prices of items of the character comprising plaintiff's inventory at April 30, 1920, particularly cotton merchandise. A small decline occurred after the Armistice, but an increase began shortly thereafter, and by the spring of 1920 prices were between three and four hundred per cent. in excess of pre-war prices. The peak of prices for most of the articles contained in plaintiff's inventory was reached in March and April, 1920, though in some instances the peak was reached as early as February and in others as late as June of that year. During the foregoing period there was a large amount of speculation in such merchandise, so that by April 30, 1920, merchants, jobbers, and retailers had purchased much in excess of their immediate needs at the prevailing prices. So great was the demand for goods during the aforementioned period that the mills allotted their goods on the basis of orders received; in other words, the demand exceeded the supply and only a part of the orders could be filled.
(b) During the fiscal year ended April 30, 1920, the output of mills dealing in goods of the character purchased to the largest extent by plaintiff was sold for delivery from two months to a year from the time the order was placed, and, as a result, at April 30, 1920, such mills had sufficient orders to take care of their capacity output for several months after that date.
(c) Because of the very great increase in prices which had occurred by the early part of 1920 in the textile industry, trade journals and leaders in the industry were sounding warnings in February, March, April, and May, 1920, of possible and probable danger from the existing prices, and urging a conservative course. During April, 1920, banks and the Federal Reserve Board placed restrictions upon credits in that industry, and in general adopted a cautious and conservative course of action. While all parties did not share a feeling of pessimism as to the future of the industry in April, 1920, there was a general feeling of uneasiness and uncertainty at that time as to existing conditions and as to the future trend of the market. Many were of the opinion that prices were too high and that a reduction therein was imminent. Prior to April 30, 1920, the consuming public had begun to protest existing prices, and such protests were being expressed by overall and old clothes parades.
(d) Prior to April 30, 1920, little, if any, reduction had occurred in either retail or wholesale prices of goods of the character included in plaintiff's inventory at April 30, 1920 (except as to silk goods), and at April 30, 1920, such prices were substantially in excess of those at which plaintiff had acquired the items contained in its inventory on that date. May 3, 1920, one of the largest department stores in the country announced a reduction, for a limited time, of 20 per cent. from its regular prices, and reprinted in its advertisement the following news item from Washington, D.C., dated April 29, 1920:
"Reports from Federal Reserve agents show a marked tendency of prices to resume their upward movement, the Federal Reserve Board reported tonight, but the Board noted the hopeful sign, from the consumer's viewpoint, of `anxiety concerning the overstrained situation resulting from excessively high prices and wages' which it believed forecast a slowing down in the skyrocketing of prices.
"While high prices of necessaries obviously were chargeable to inefficiency and underproduction to a large degree, the Board advanced the belief that the high costs of production were aggravated by the added expense of obtaining capital.
"The Board `viewed with some alarm' the question of obtaining adequate labor for the farms. This question was considered the most difficult element of the whole labor situation.
"All lines of manufacturing have shown unprecedented activity, with textile makers leading in capacity operation. In the shoe and leather field, however, a `mixed situation' exists, which in some cases has resulted in a semistagnation."
Its advertisement concluded with the following statement:
"We are simply mastered by a spirit of duty to help the people who have helped us in this renewed effort to start a movement in lowering selling prices of merchandise and bring on more quickly the `better days coming' to this Nation."
Thereafter other retail stores throughout the country announced similar reductions. A reduction in wholesale prices, however, of the character of goods included in plaintiff's inventory did not occur until later, beginning to a small extent as early as June but not reaching any material amount until the late summer and early fall of 1920. Wholesalers generally continued at least through June, 1920, to quote prices made prior to April 30, 1920. In some instances where new price lists would ordinarily have been prepared during the period from April to August, 1920, such action was not taken, due to the unsettled condition of the market, and the old quoted prices continued in effect. A major factor in the continuation of the existing price level was that a large number of sales had been made prior to April 30, 1920, at the prevailing prices for delivery during the succeeding months thereafter, and the sellers were desirous of having the contracts fulfilled and of not taking any action which might tend to precipitate attempted cancellations of contracts. However, cancellations were made in many instances, though the cancellations made were small in comparison with the total orders outstanding April 30, 1920. In many instances when cancellations were sought the wholesalers insisted on the fulfillment of the contracts, whereas in other cases price adjustments and substitutions of goods were made as a matter of policy, either because of the financial condition of the purchaser or for some other reason, to facilitate the carrying out of the contracts as far as possible.
(e) While the sales made during the remainder of 1920 after April 30 of the character of items contained in plaintiff's inventory on that date were small in volume as compared with those during the months immediately preceding April 30, there was a substantial amount of trading during such period, and the prices prevailing in such sales — at least during May and June, 1920 — were not less than those prevailing during the 12-month period ended April 30, 1920. In many instances the sales then made were to purchasers who, from time to time, desired small quantities of particular goods to replenish certain parts of their depleted stock, and, in such sales, reductions were sometimes made from the quoted prices. During the latter part of 1920 and early part of 1921 substantial reductions were made by wholesalers and jobbers in the market price of goods of the character contained in plaintiff's inventory at April 30, 1920, and by January, February, and March, 1921, a normal volume of trading was attained at prices as low as 50 to 75 per cent. below the prices prevailing at April 30, 1920. The reduction in price did not reach the level of price prevailing in the latter part of 1919 and early part of 1920 until at least three months subsequent to April 30, 1920, with the possible exception of silk goods or part-silk goods, and as to these goods the record is insufficient to show either a comparison of prices or the extent to which such goods entered into plaintiff's inventory at April 30, 1920. (See finding 6 for a comparison of the cost of plaintiff's inventory with the market value of such inventory when priced at the prices prevailing during the first three months of 1921.)
6. A summary of plaintiff's inventory at April 30, 1920, showing the inventory priced (1) at cost, (2) at cost, less shrinkage, as defined in finding 4, such inventory being that used in the return as filed for the fiscal year ended April 30, 1920, and (3) at prices prevailing in January, February, and March, 1921, is as follows:
Market prices Cost Cost less prevailing "shrinkage" January, (used in February, and return) March 1921
Departments
39 Work shirts ......... 8,017.97 8,017.97 5,617.67 40 Work shirts, mill shipment ...... 1,769.37 1,769.37 1,222.77 41 Flannel shirts ...... 16,579.77 13,819.96 14,073.37 42 Dress shirts ........ 86,293.12 74,196.90 69,053.50 43 Collars ............. 1,231.30 1,231.30 1,231.30 54 Night shirts and pajamas ........ 15,871.87 14,107.43 12,684.25 44 Overalls and work clothing ...... 55,784.34 55,784.34 44,201.50 48 Neckwear ............ 50,784.89 40,584.31 40,656.61 49 Handkerchiefs ....... 3,654.74 3,654.74 3,654.74 50 Belts, suspenders, and garters ........ 9,854.85 8,567.39 8,547.39 60 Boys' wash suits .... 67,219.41 67,219.41 56,325.72 61 Boys' shirts and blouses ........ 34,471.84 31,351.41 29,234.32 62 Boys' suits, shirts, and blouses ........ 36,719.06 36,719.06 32,594.32 388,252.53 357,023.59 319,097.46
Factories
Cutting room ........... 572,536.24 439,570.09 323,099.09 Carondelet ............. 55,090.39 55,090.39 38,741.33 Madison ................ 137,977.12 137,474.40 98,931.59 Webb City .............. 121,234.29 121,234.29 65,835.39 Edwardsville ........... 41,143.03 41,143.02 25,828.57 Ste Genevieve .......... 34,851.58 34,851.58 27,259.51 Night shirt and pajama factory ........ 83,962.55 83,962.55 40,299.90 Overall and work clothing .............. 117,568.65 117,568.65 72,149.41 Neckwear factory ....... 84,588.90 51,235.76 51,288.85 Belt and suspender factory ............... 25,910.28 18,935.66 18,924.45 Boys' wear factory ..... 348,396.69 340,009.78 236,287.35 McLeansboro ............ 24,762.67 24,762.67 14,417.72 1,648,022.39 1,465,838.85 1,013,063.16 Manufacturing departments ........... 2,036,274.92 1,822,862.44 1,332,160.62
Jobbing Departments
70 Hosiery ............. 268,683.06 230,322.54 183,490.62 75 Underwear ........... 305,960.48 305,960.48 247,549.67 80 Knit goods........... 71,331.35 71,331.35 61,000.74 Fall season merchandise in house and in transit at April 30, 1920 .................. 62,098.00 62,098.00 43,010.50 708,072.89 669,712.37 535,051.53 2,744,347.81 2,492,574.81 1,867,212.15
7. A market existed at April 30, 1920, for items of the character contained in plaintiff's inventory on that date, and such market was in excess of cost to plaintiff of its inventory.
LITTLETON, Judge.
Plaintiff states the principal issue in this case as being "whether the definition of `market' as the `current bid price' set out in the regulations [art. 1584] is applicable under the facts and circumstances of this case so as to require that plaintiff's inventory be valued according to quoted prices," and contends (1) that the definition of market as the current bid price is applicable only under ordinary circumstances and not when market conditions are stagnant and quoted prices are nominal and such trading as occurs is in quantities greatly less than the volume usually purchased by the taxpayer; (2) that, in this case, it is established that during the period from April 30, 1920, until early in 1921, the market for goods, such as comprised plaintiff's inventory, was stagnant; that quoted prices were nominal and such trading as occurred was in very small quantities greatly less than the quantities usually purchased by the taxpayer; and (3) that under the facts and circumstances of this case the value of plaintiff's inventory for tax purposes is to be determined by reference to the market prices at which similar goods were sold in January, February, and March, 1921, which was lower than such cost.
Plaintiff excepts to findings 5(d) and (e) and 7 by the commissioner of this court, but we think these findings are amply sustained by the evidence, and the exceptions are denied.
The important and controlling fact in the case is whether there was a market on April 30, 1920, and whether the market price on that date was in excess of plaintiff's costs. This fact is stated in finding 7, and plaintiff's exception thereto is predicated upon the view that the sales on that date, being in less volume than for some months previous to April 30, 1920, fail to constitute a market within the meaning of the statute and the regulations. This is the crux of the whole case. Although it is true that the amount of sales of merchandise of the character comprising the plaintiff's inventory was less in volume on and near April 30, 1920, the evidence shows that there were daily sales in considerable volume. But the volume of the sales is not controlling if there is an established market price for such merchandise on the inventory date and such market is ascertainable. Herein we think lies the error in plaintiff's argument.
The term "market" used in the statute and the regulations in the phrase "cost or market, whichever is lower," means the market price which plaintiff would have to pay for the merchandise in the inventory on the inventory date and not the price at which he sells such merchandise or offers it for sale. The evidence in this case shows that there was a market for the merchandise contained in plaintiff's inventory and that the market price therefor prevailing on the inventory date was higher than the cost to plaintiff of its inventory. The market price for the merchandise on April 30, 1920, had not been reduced below what it had been for some time previous, and no reduction in such market price occurred until some time in August or September, 1920. In these circumstances we think the Commissioner of Internal Revenue properly interpreted and applied the statute and the regulations in question by using cost, since cost was lower than market on the inventory date. Plaintiff is in error in the contention that this case falls within the last sentence of article 1584 to the effect that, "where no open market exists or where quotations are nominal due to stagnant market conditions, the taxpayer must use such evidence of a fair market price at the date or dates nearest the inventory or as may be available, such as specific purchases or sales by the taxpayer or others in reasonable volume and made in good faith, or compensation paid for cancellation of contracts for purchase commitments." The quoted portion of the regulations has reference to quotations of nominal prices for merchandise due to stagnant market conditions, and does not apply to a case where, although the volume of sales may have been less on the inventory date than previous to that time, there is nevertheless an established and existing market price for such merchandise. The words "quotations are nominal" appearing in the regulations do not refer to the volume of sales but to quoted prices for the merchandise. The words "reasonable value" contained in the last portion of the quoted provision of article 1584 have reference to the determination of value of the inventory by the use of a market price at the date or dates nearest the inventory date, where the market price at which such merchandise is offered on the inventory date is nominal due to stagnant conditions, and have, therefore, no controlling influence on this case.
Plaintiff is not entitled to recover, and the petition must be dismissed. It is so ordered.