Memorandum Findings of Fact and Opinion

TIETJENS, Judge: The Commissioner determined deficiencies in petitioner's income tax as follows:

We must decide whether, for each of the taxable years in question, petitioner was availed of for the purpose of avoiding income tax with respect to its shareholders by permitting earnings and profits to accumulate instead of being divided or distributed, and is thus subject to the accumulated earnings tax imposed by section 531 of the 1954 Code. ¹ This1969 Tax Ct. Memo LEXIS 91">*93 is the only issue before us. ²

1083

Findings of Fact

Some of the facts have been1969 Tax Ct. Memo LEXIS 91">*94 stipulated and are so found. The stipulation and the exhibits attached thereto are incorporated herein by this reference.

Kingsbury Investments, Inc., is a New Hampshire corporation having its principal place of business in Keene, New Hampshire, at the time of the filing of its petition herein. Petitioner timely filed its Federal corporation income tax returns for the taxable years in question with the district director of internal revenue, New Hampshire.

Pursuant to the provisions of Section 534 the Commissioner notified petitioner of his intent to issue a statutory notice of deficiency for the years 1961, 1962, and 1963 setting forth an amount with respect to section 531 relating to the accumulated earnings tax. By letter dated September 30, 1965, the petitioner submitted to the Commissioner a statement intended to comply with the provisions of section 534(c). This statement set forth the following grounds on which petitioner relies to establish that its earnings and profits have not been permitted to accumulate beyond the reasonable needs of its business:

A. Increased inventory requirements totaling an estimated $2,000,000 existed throughout the three year period.

B. Increased1969 Tax Ct. Memo LEXIS 91">*95 Plant and Equipment needs of more than $1,000,000 existed throughout the three year period.

D. Key management was in a transitional stage and the new personnel were untested.

E. Product Diversification was a significant requirement throughout the periods involved as were the necessity for a Service Center and development of the foreign market potential.

F. The necessity existed of continuing dividends at a rate at least approximate to those maintained in the years past.

G. The uncertainties of the automobile machine tool makers industry justified a significant reserve to meet unpredictable needs. * * *

In summary, the prudent needs of the business of Kingsbury Machine Tool Corporation at the conclusion of each of the fiscal years ended in 1961, 1962, and 1963 were in round figures as follows:

By order1969 Tax Ct. Memo LEXIS 91">*96 dated June 5, 1968, this Court granted petitioner's motion that the burden of proof be upon the Commissioner with respect to the grounds set forth in petitioner's statement.

Kingsbury Investments, Inc., is presently a personal holding company. Until June 1964, Kingsbury Investments, Inc., was in the machine tool business under the name Kingsbury Machine Tool Corp., a New Hampshire corporation. At that time Kingsbury Machine Tool Corp. (New Hampshire) while retaining cash and securities, sold all of its operating assets, including accounts receivable, inventory, machinery, land and buildings to the newly created Kingsbury Machine Tool Corp. (Delaware), a Delaware corporation. Kingsbury Machine Tool Corp. (New Hampshire) and its successor Kingsbury Investments, Inc., the nominal petitioner herein, are hereinafter sometimes referred to simply as Kingsbury or petitioner.

Kingsbury's business since its incorporation in 1928 has been the manufacture of machine tools which are sold in nearly all parts of the United States, most sales being to customers in the automotive industries in Ohio, Indiana, and Michigan. Kingsbury has addressed itself primarily to designing, engineering and manufacturing1969 Tax Ct. Memo LEXIS 91">*97 machines for metal removal in the automotive industry. It manufactures machines used in making carburetors, distributors, automobile transmissions and other small automobile equipment pieces. The pressure toward greater automation in the automotive industry has been constant. Until 1956 the automotive industry employed a dial or radial type columnar machine having a 1084 series of stations on its circumference for performing metal removal operations. Such a machine could be manufactured in about 9 months and cost less than $100,000. The basic machine has been continuously improved during the past decade. The number of stations have increased from about 8 to 18, thus increasing the number of metal removal operations the machine is capable of performing. The cost of the improved radial type machine is around $250,000. Its manufacture requires approximately a year. Each machine is individually manufactured on order.

Concurrently with the expanded requirements in the rotary type machine, the pressure toward increased automation in the automotive industry resulted in demand for a machine capable of performing all operations necessary to complete the tooling job on a piece of metal1969 Tax Ct. Memo LEXIS 91">*98 stock. The "inline" machine, having a series of stations in line with one another rather than on the circumference of the machine, is such a machine, having no theoretical limit to the number of operations it is capable of performing. The in-line machine requires one operator to insert the raw-stock metal and remove the tooled component. One in-line machine and one operator replace a number of rotary type machines and their respective operators. Pressure to design and build an in-line machine was brought to bear on Kingsbury Machine Tool Corp. in 1955 by certain of its customers and agents. Kingsbury was reluctant to embark on this new venture recognizing that expenditures in terms of engineering and machinery costs could run well over a half million dollars, while observing at the same time its competitors were encountering difficulties with the new type machines. As of December 1956, Kingsbury had decided that its entrance into the in-line field at that time would be premature.

By 1958 it became apparent that Kingsbury's development of an in-line machine was a competitive necessity. The decision was made to enter this field. Kingsbury, however, had had no experience with this type1969 Tax Ct. Memo LEXIS 91">*99 of unit. The early in-lines were multimillion dollar machines for producing large pieces of automotive equipment such as engine blocks, whereas Kingsbury's experience was with small automotive parts.

An intensive study program was adopted. Twelve of Kingsbury's top personnel, including its sales manager, service manager and chief engineer, were sent on visitation programs to study the machine and its market. The engineering effort began in 1959 and a working prototype was in operation by September 1961. This prototype consisted of 2 stations plus the track and pallet between them. Buying programs were underway in the automotive industry at that time and Kingsbury wanted to be considered on in-line requests at that time.

Kingsbury received requests for bids on in-lines for Ford dated February 9, 1962 and March 23, 1962. Bids were submitted in the amounts of $840,254 and $217,684, respectively. While they received serious consideration from Ford, these bids were unsuccessful. It was not until 1964 that Kingsbury was successful in its bid on an in-line similar to the $840,000 one bid in 1962. In the meantime, Kingsbury had designed, engineered and built three prototype transfer machines1969 Tax Ct. Memo LEXIS 91">*100 of different design in an effort to develop one that would be satisfactory.

Increased Plant and Equipment Needs

Kingsbury anticipated in 1961 that, if it were successful in its bidding on a major in-line machine, its manufacture of such a machine would necessitate expansion of its plant facilities to accommodate the larger floor space that would be required. Additional machine tools and other equipment also would have to be purchased. While these needs were anticipated in 1961, they did not materialize until 1964 when Kingsbury had successfully bid on a large in-line. The machinery and building requirements of petitioner's machine tool business since September 1962 have totaled in excess of $1,000,000. Extraordinary expenditures for plant expansion and purchase of additional machinery in an amount exceeding $1,000,000 were actually and reasonably anticipated by petitioner as of 1961.

Increased Inventory Requirements

Kingsbury also anticipated a substantial increase in its cash requirements to finance the increased inventory that would result from a successful in-line bid. Kingsbury's customers did not finance the construction of these machines by the making of progress payments1969 Tax Ct. Memo LEXIS 91">*101 or by any other means. Since Kingsbury's entrance into the manufacture of in-lines, its inventory levels have increased by more than $1,700,000. The increased inventory requirement in an amount of at least $2,000,000 was a reasonably and 1085 actually anticipated need of the business as of 1961.

Accumulated Earnings and Profits

Petitioner's accumulated earnings and profits and the increase in petitioner's earnings and profits over prior years were as follows:

Net Working Capital

Petitioner's net working capital during the taxable years 1960 through 1963 was as follows: ³1969 Tax Ct. Memo LEXIS 91">*102

The parties are in dispute as to whether petitioner's investment in Kingsbury Manufacturing Co. should be included in the computation of its net working capital. Kingsbury Manufacturing Co. is a wholly owned subsidiary of petitioner with a net worth of $290,000, $294,600, and $298,085 as of the end of petitioner's fiscal years ended 1961, 1962, and 1963, respectively, as shown in the following summary balance sheet:

Cheshire Investments, Inc., a wholly owned subsidiary of Kingsbury Manufacturing Co. 1969 Tax Ct. Memo LEXIS 91">*103 , had a net worth of $133,300, $134,500, and $135,999 as of the end of petitioner's fiscal years ended 1961, 1962, and 1963, respectively, as shown in the following summary balance sheet:

Cheshire's investment in Winding Brook Lodge (W.B.L.), a motel and restaurant located in Keene, was made as part of a joint effort of the Keene business community to provide lodging facilities for their respective customers. We have decided that petitioner's continuing investment in this facility does not represent a need of petitioner's business. For this reason, we have treated petitioner's investment in this facility (at cost) as available to meet petitioner's working capital needs. Nor has petitioner shown that Cheshire's fixed assets were related1969 Tax Ct. Memo LEXIS 91">*104 to the conduct of petitioner's machine tool business. Nor do we know anything about petitioner's indirect investment in Pinnacle Mt. Development. As none of Cheshire's investments were sufficiently related to petitioner's business, we have not considered Cheshire's operating needs, if any, as being so related. The figures of $21,700, $20,000 and $18,282 representing Kingsbury's net fixed assets for the fiscal years ended 1961, 1962, and 1963, respectively, apparently represent Kingsbury Manufacturing Co.'s ownership of a building which it rented to petitioner. Obviously this building, which was used in petitioner's business, cannot be considered available to meet petitioner's capital requirements. Petitioner has not shown, however, that any amount was required to meet the capital needs of maintaining this rental property - the maintenance of this property constituting the only business of Kingsbury Manufacturing Co. that is related to petitioner's machine tool business. Accordingly, we have included in our computation of petitioner's net working capital the net worth of Kingsbury Manufacturing Co., deducting therefrom only the amounts representing Kingsbury Manufacturing Co.'s fixed1969 Tax Ct. Memo LEXIS 91">*105 assets.

Working Capital Needs

Petitioner required working capital as of the end of the years involved in an amount 1086 at least sufficient to cover its reasonably anticipated cost of operating a single operating cycle. An operating cycle for petitioner consisted of the time required to convert cash into inventory, inventory into sales, and accounts receivable into cash by collection thereof. Petitioner required the following amounts to finance a single operating cycle:

1969 Tax Ct. Memo LEXIS 91">*106 1087

During the years involved herein there were 115,439 shares of stock of petitioner issued and outstanding. The principal shareholders were the following persons who owned the number of shares indicated for each of the years involved:

Petitioner has a long history of paying substantial dividends on a regular basis. During the years involved herein petitioner paid the following dividends shown as a percentage of its net profits:

Several of petitioner's shareholders were in tax brackets which exceeded 50 percent for each of the years in question. Increased dividend payments by petitioner would have been taxable to these shareholders at rates exceeding 50 percent.

Petitioner has made no loans to shareholders or otherwise made corporate property available to or for the benefit of its shareholders. Petitioner had a longstanding policy against borrowing money.

Opinion

We must decide whether during its taxable years 1961 through 1963, petitioner was availed of for the purpose of avoiding income tax to its shareholders by permitting earnings and profits to accumulate instead of being divided or distributed, thus rendering it liable for the accumulated earnings tax imposed by section 531. See sections 531 through 537 of the 1954 Code, as amended, the pertinent provisions of which are set out below. ⁵Section 531 imposes the accumulated earnings tax; section 532 provides that every corporation formed or availed of for the purposes of avoiding the income tax of its shareholders by permitting earnings and profits to accumulate instead of being divided or distributed shall be subject to the tax; section1969 Tax Ct. Memo LEXIS 91">*108 533 provides that the fact that earnings and profits are permitted to accumulate "beyond the reasonable needs of the business" shall be determinative of such purpose unless the corporation by the preponderance of the evidence shall prove to the contrary; section 534 deals with the burden of proof; section 535 defines "accumulated taxable income" upon 1091 which the tax under section 531 is based; section 536 is not here material; and section 537 provides that the term "reasonable needs of the business" includes the reasonably anticipated needs of the business.

1969 Tax Ct. Memo LEXIS 91">*109 This Court has recently stated that if a corporation's earnings and profits were required for the reasonable needs of the business, including the reasonably anticipated needs, the corporation is not subject to the accumulated earnings tax. Magic Mart, Inc., 51 T.C. 775">51 T.C. 775 (1969). The central issue, then, becomes "the reasonable needs of the business." Faber Cement Block Co., 50 T.C. 317">50 T.C. 317 (1968). Whether petitioner's accumulated earnings and profits were required to meet those needs involves essentially a factual determination. 50 T.C. 317">Faber Cement Block Co., supra.

We have made no fact findings with respect to petitioner's grounds C,D,E,F, or G, alleged in its section 534 statement to establish that its earnings and profits have not been permitted to accumulate beyond the reasonable needs of its business. In our view, petitioner's alleged anticipated needs for increased inventory and for plant and equipment expansion, combined with its actual current needs for each year, expressed in terms of its net operating cycle needs, make such findings unnecessary; 1969 Tax Ct. Memo LEXIS 91">*110 these needs alone exceed petitioner's net working capital available to meet more needs.

The parties seem to agree that petitioner required working capital at the end of each of the years involved in an amount at least sufficient to cover its reasonably anticipated cost of operating for a single operating cycle. However, they are in dispute as to the amount of such anticipated costs for each year. We have found the costs of operating for a single cycle to be $2,806,720, $2,881,535, and $2,131,762, respectively, for the years 1961, 1962, and 1963. In so finding, we have adhered closely to the general guidelines set forth in 51 T.C. 775">Magic Mart, Inc., supra, and the cases cited therein. Our computation of those needs is set out in footnote 4 to our findings of fact. The differences between petitioner's net working capital, $3,925,500, $4,638,400, and $4,944,603, respectively, for the years 1961, 1962, and 1963 and petitioner's working capital needs, $2,806,720, $2,881,535, and $2,131,762, respectively, for the years 1961, 1962, and 1963, being $1,118,780 in 1961, $1,756,865 in 1962, and $2,812,841 in 1963, represent working capital which was available to meet the reasonably anticipated1969 Tax Ct. Memo LEXIS 91">*111 needs of petitioner's business. We have found those needs to be at least $3,000,000 for each year, $1,000,000 for plant expansion and the purchase of additional machinery and $2,000,000 for anticipated increased inventory requirements. Accordingly, we find that petitioner's business needs exceeded its net working capital available to meet those needs in each of the years involved herein. It follows that petitioner is not subject to the accumulated earnings tax. 51 T.C. 775">Magic Mart, Inc., supra.

The Commissioner contends that Kingsbury did not actually anticipate the alleged anticipated needs for inventory, and for plant expansion and additional equipment. Even though subsequent events may have demonstrated that petitioner's retained profits have not exceeded the actual needs of petitioner's business, the crucial question relates to petitioner's intentions at the time of the accumulations. A purpose to evade tax with respect to its shareholders must not have been present when the earnings and profits were allowed to accumulate. United States v. Donruss Co., 393 U.S. 297">393 U.S. 297 (1969).1969 Tax Ct. Memo LEXIS 91">*112 Subsequent events cannot be used to show the existence of a plan to use the accumulations or the reasonableness of an accumulation if no subjective determination of need had been made at the time of the accumulation. 50 T.C. 317">Faber Cement Block Co., supra.

Specifically, the Commissioner's regulations state that in order to justify an accumulation of earnings and profits for reasonably anticipated future needs, there must be an indication that the future needs of the business require such accumulation "and the corporation must have specific, definite, and feasible plans for the use of such accumulation." Section 1.537-1(b)(1), Income Tax Regs. The purpose behind this requirement is obvious - the courts must be able to distinguish between corporations which have allowed their earnings to accumulate for the purpose of meeting business needs and corporations which have accumulated with a purpose to evade taxes with respect to their shareholders and which later seek to justify the accumulation in terms of bogus needs, fabricated in the light of hindsight for the1969 Tax Ct. Memo LEXIS 91">*113 purpose of defending against the accumulated earnings tax. We think Kingsbury's plans for the use of its accumulated earnings were "specific, definite, and feasible" within the meaning of the above-quoted 1092 regulation. Its entrance into the in-line field, specifically into the manufacture of the large in-lines, was recognized as a competitive necessity prior to 1961. During the several years preceding, and during 1961 and 1962, it was in active pursuit of in-line business. It sent its engineers out into the field to study its competitors' in-lines; it manufactured two prototype transfer machines and engineered basic improvements in the in-line; it bid for the manufacture of numerous in-lines, including a bid for an $840,000 in-line for Ford in 1962. These actions speak louder than words. We are persuaded that the decision to enter the inline field had been made prior to 1961. In light of the circumstances then known to petitioner's management, the full implementation of this decision, depending upon the success of petitioner's bids, would of necessity require extraordinary capital expenditures of $3,000,000. The fact that petitioner did not have blueprints for its plant expansion, 1969 Tax Ct. Memo LEXIS 91">*114 when the nature and extent of that expansion would depend upon future developments should not be fatal. We are persuaded that needs in these amounts were reasonably and actually anticipated. Petitioner's plans were as specific, definite and feasible as was possible in light of the extraordinary nature of its business. We are impressed with the fact that to a very large degree the anticipated needs actually materialized upon petitioner's successful entrance into the in-line business in 1964. 50 T.C. 317">Faber Cement Block Co., supra.

Decision will be entered under Rule 50.