author: Milliken:

text:
    Appeal of Owen-Ames-Kimball Co.
    Docket No. 1637.
    Promulgated December 23, 1926.
    1. The income from long-term contracts taken on the bases of lump sums, cost plus a fixed fee or plus a percentage, and cost plus a fixed fee with a guarantee that the total price was not to exceed a certain sum, is properly aecruable during the period of construction in the same ratio that the work completed in each year bears to the whole.

      2. Where such income is accrued at intervals having no regard for a uniform method or an apportioned ratio and the return is made in accordance with such accruals, the application of the accrual system is faulty and the return does not correctly reflect income.

      Harry Friedman, Esq., and J. Robert Sherrod, Esq., for the petitioner.

      Ward Loveless, Esq., for the Commissioner.
    This is an appeal from the determination of deficiencies in income and profits taxes for the years 19It and 1918, in the amounts of $474.84 and $3,528.48 respectively, a total of $4,003.27. Of the four issues set out in the petition, two have been withdrawn by the petitioner, while the Commissioner admits error in respect of another, leaving only the issue as to the proper method of computing petitioner’s income from construction operations under long-term contracts.
    BINDINGS OF FACT.

    Petitioner, a Michigan corporation, with its principal office at Grand Kapids, was organized in 1909 under the name of Hauser-Owen-Ames Co., its name having been changed in 1918 to Owen-Ames-Kimball Co. Its business is that of a contractor engaged in building and construction work.
    During the years 1917 and 1918, petitioner was engaged in building and construction work under approximately 83 contracts. These contracts were of four kinds which, when classified according to the terjps of compensation, are as follows:
    (1) Cost plus a fee representing a percentage of the cost of labor, materials, and expense entering into the work;
    (2) Cost plus a fixed fee;
    (3) Cost plus a fixed fee, with a guarantee that the total price shall not exceed a certain amount; and
    (4) Lump-sum contracts.
    Of the 83 contracts referred to above, there were 13 under which the petitioner commenced work in one taxable year and completed the work in another taxable year. These 13 contracts, briefly described, are as follows:
    (1) Ashton Building Contract. — This was an oral agreement under which the petitioner was to receive, as its compensation, 10 per cent of the cost of labor and material entering into the work. There was no agreement as to the time the petitioner was to receive its compensation.
    (2) Clipper Belt Laeer Co. — This contract provided for the wrecking of an old garage and the erection of an addition to the owner’s plant for actual cost of labor and material, plus a commission equal to 10 per cent of the cost of all labor and material entering into the construction of the building. There was no agreement as to the time the petitioner was to receive its compensation.
    (3) Duplex Truck Oo. — This contract, dated June 1, 1917, provided for the construction of a factory for the actual cost of all labor and material, plus a fee of $10,000. Payments were to be made on or before the tenth of every month for the actual cost of all material purchased and labor paid for, the final payment, which was to include the fee of $10,000, to be made within thirty days from completion of the contract. Work was completed under this contract prior to the close of the year 1917. After the contract was completed, additional work was done for the owner, under an oral agreement, for which the petitioner was to receive an additional fee of $1,000. No date for the payment of this additional fee was fixed. The additional work extended into the year 1918.
    (4) Grand, Rapids Furnitwe Oo. — This contract, dated September 12, 1916, provided for- the erection of an addition to a factory for the actual cost of labor and material plus a fee of $2,000, the total cost, including the $2,000, not to exceed the sum of $20,000. No dates of payment are specified in the contract.
    (5) Grand Rapids Plaster Go. — Work was done for this company under a verbal agreement, on the basis of cost of labor and materials plus 12½ per cent of such cost.
    (6) Globe Knitting Mills. — The work for this company was done under two contracts, one dated May 25, 1916, and the other dated July 10, 1916. The contract dated May 25, 1916, provided for the erection of foundations for a factory building for actual cost of labor and material, plus a commission equal to 8 per cent of the cost of all labor and material entering into the construction work. Payments were to be made on the first of each month, or oftener, equal to the net cost of labor and materials incurred since the next previous payment. Final payment, consisting of any part of the net cost remaining unpaid and the commission of 8 per cent on the total net cost, was to be made within thirty days after completion and acceptance of the work.
    The contract dated July 10, 1916, provided for the erection of a factory building for the actual cost of all labor, material and expense incurred incident to the fulfillment of the contract, plus a commission equal to 8 per cent of said cost. Payments were to be made on the first of each month, or oftener, equal to the net cost of labor and materials incurred since the next previous payment. Final payment, consisting of any part of the cost remaining unpaid and the commission of 8 per cent of the total net cost, was to be made within thirty days after completion and acceptance of the work. Work was to be completed on or before December 1, 1918, and, in the event of failure to complete the work within the time specified, contractor to pay liquidated damages of $20 per day.
    (7) Gar della Gontract. — This was a contract for the erection of a building for the lump sum of $32,500. The contract was completed prior to the close of the year 1917. The contract did not specify how the contract price was to be paid.
    (8) Nelson^Matter Furniture Go. — Contract for the construction of a factory building, boiler house, and dry kilns. The contract provided that the petitioner shall receive the net cost of all labor performed and material furnished and expense incurred incident to the fulfillment of the contract and, in addition thereto, the sum of $6,000. Payments were to be made on the first of each month, or oftener, equal to the net cost of labor, material and expense incurred since the next previous payment. Final payment, consisting of any part of the net cost remaining unpaid and the commission of $6,000, was to be made within thirty days after completion and acceptance of the work. The work under this contract was completed prior to the close of the year 1916. The contract did not provide for extras. Additional work was done for the owners on the basis of cost of all labor and material, plus a commission of 10 per cent. Owing to financial difficulties of the owner, the petitioner reduced the commission on this additional work to $2,000. There was no agreement as to the date the commission on the additional work was to be paid.
    (9) Overland Garage Gontract. — Contract for the erection of a service building. The petitioner received the total cost of all labor and material entering into the construction of the building, plus a commission equal to 10 per cent of such cost. The contract provided that the total cost, including petitioner’s commission, should not exceed the sum of $63,000. The contract was completed in December, 1917.
    (10) Pere Marquette Railroad Go. — Contract for the erection of a car shed on the basis of cost, plus a commission equal to 10 per cent of cost. The contract provided that payments were to be made on the fifteenth day of each month while the work was in progress for all labor and materials furnished during the next preceding month; final settlement to be made within thirty days after completion and acceptance of the work.
    (11) W. K. Prudden <& Go. — Contract for the erection of a factory building for the actual cost of all labor and material, plus a commission equal to 2 per cent of such cost. No dates oí payment are specified in the contract.

      (12) Paul Stekatee Realty Go. — Contract provided for the erection of a department store building, at a cost of all labor and material entering into the construction, plus a commission of $10,000, the total cost, including commission, not to exceed the sum of $109,-726. Payments to be made at intervals sufficiently frequent to permit the petitioner to discount all discountable bills. Final payment, consisting of any part of the cost remaining unpaid, plus commission, to be made within thirty days after completion and acceptance of the work.
    (13) D. E. Waters Garage. — Contract for the construction of a garage on the basis of cost of all labor and material furnished, plus a commission equal to 10 per cent of such cost. The agreement was verbal. There was no agreement as to the date of payment.
    The petitioner’s books of account were maintained upon the accrual basis but were faulty in their inconsistent application of the accrual basis. In the system of accounts there was no uniform method of accruing income from long-term contracts. Without regard for the terms of the contracts, as to the time and manner of compensation, income from some of these contracts was accrued on the books of account' at the time of commencement of work; income from other contracts was accrued on the books at irregular intervals without any definite basis; and income from still other contracts was accrued only upon completion of the entire work.
    The original returns filed by the petitioner for the taxable years 1917 and 1918 were prepared in accordance with its books of account. Subsequently the petitioner filed amended returns of net income for the years 1917 and 1918, in which gross income from long-term contracts was computed as follows: The gross income derived from contracts in which the compensation was fixed at the actual cost of all labor and material, plus a commission equal to a fixed percentage of such cost, was determined by applying to the total expenditures fox-labor and material made within each year the rate per cent of the commission provided for in the contracts; and the gross income from all other contracts, cost plus a fixed fee, cost plus a fixed fee with a guarantee as to the maximum amount, and lump-sum contracts, was determined by applying to the amoimt of the fee, in the case of contracts of the two classes first mentioned, or to the amount of the actual profit in the case of lump-sum contracts, the percentage which the total expenditures for labor and material made in each year were of the total actual expenditures under the several contracts. In this maimer the gross income under each contract was computed separately. Only in the case of the 13 contracts, herein-before described, did the gross income as computed in the amended returns differ from that shown by the books of account and the original returns.
    The Commissioner rejected the amended returns on the grounds that the petitioner’s books of account were maintained upon the completed-contract basis; and that the petitioner, having elected to maintain its books and render its returns on the completed-contract basis, could not thereafter, without his permission, change its basis of accounting for income-tax purposes to the basis upon which the amended returns were prepared, the necessary permission having neither been requested by the petitioner nor granted by the Commissioner.
   OPINION.

Milliken:

The petitioner is engaged in building and construction work, principally under contracts. During the years involved in this appeal it was carrying on such work under approximately 83 contracts. The work under at least 13 of its contracts was begun in one taxable year and completed in another taxable year; and the income derived from these contracts, in each of the years in question, is the issue which we are called upon to decide.

Under the provisions of section 13 (d) of the Revenue Act of 1916, a taxpayer maintaining its books of account upon a basis other than that of actual receipts and disbursements, was permitted to make its return upon the basis upon which its accounts were kept, provided such basis clearly reflected its net income. Under the provisions of section 212 (b) of the Revenue Act of 1918, it was mandatory upon a taxpayer to compute its net income, for the year 1918, in accordance with the method of accounting regularly employed in keeping the books of account, if the method employed clearly reflected the net income. The petitioner filed returns for the years 1917 and 1918, in both of which it computed its net income in accordance with the method employed in keeping the books of account. The Commissioner made adjustments in the net income, as reported in the returns, disallowing certain deductions which he deemed to be unallowable and unreasonable in amount, which resulted in his determination of a deficiency in respect of both years. The petitioner does not dispute the correctness of the several adjustments made by the Commissioner. It contends, however, that any computation of net income, for the two years under consideration, based upon the method employed in keeping its books of account, must necessarily be erroneous, since the method employed did not clearly reflect its net income, and that the Commissioner erred in failing to determine the net income upon a basis which would clearly reflect what the net income was. The important question is then — Does the method employed in keeping the petitioner’s books of account, during the years involved in this appeal, clearly reflect its net income? If not, the petitioner is entitled to have its net income recomputed upon a basis which will clearly reflect its net income and to a redetermination of its tax liability upon the net income so computed.

It can not be said that any definite method was employed in keeping the petitioner’s books of account. Certain it is that the manner in which the books were kept did not conform either with the cash receipts and disbursements method or the accrual method of accounting, the two alternative methods provided by statute for keeping accounts and making returns of income. Appeal of Chatham & Phenix National Bank, 1 B. T. A. 460; Appeal of Henry Reubel, 1 B. T. A. 676; Appeal of B. B. Todd, Inc., 1 B. T. A. 762. All items of income and expense, other than income from long-term contracts, were entered upon petitioner’s books and accounted for in accordance with the accrual method of accounting. Income from long-term contracts, an important and perhaps the chief item of income in the petitioner’s business, was accounted for on petitioner’s books in an entirely inconsistent manner. There existed no uniform practice as to the time and manner of accounting for income from that source. This income was accounted for at the caprice of the bookkeeper, at irregular periods, and in amounts which were not determined upon any definite or reasonable basis. At times the profit to be derived from long-term contracts was accounted for on the books when work was commenced. On other occasions it was taken up on the books of account during the progress of the work, but at times and in amounts that bore no relation thereto. And as a further variation, there were instances when the income was not accounted for until the completion of the work under contract. In the latter case, the accounting for that income was on the basis of actual receipts, notwithstanding that the expenses incident thereto were accounted for in a prior year and not deferred to be offset against the income. It is perhaps superfluous to say that it is a fundamental principle, in computing net income under the several income tax acts, that all items of income and expense shall be consistently accounted for on the same basis; and any method of accounting which fails to recognize and give effect to this principle will not clearly reflect net income. The facts as to the manner in which petitioner’s books of account were kept, during the years involved in this appeal, are such that we are convinced that the method employed in keeping the accounts did not conform with either of the two alternative bases provided by statute, and did not clearly reflect petitioner’s net income. It follows that any computation of net income based upon the method employed in keeping the accounts will not result in a correct determination of net income, to which the petitioner is entitled, and resort must be made to some other method.

The petitioner asks that the income from the 13 long-term contracts described in the findings of fact, for each of the years under consideration, be redetermined upon the accrual basis, that is, by treating the income as accruing during the progress of the work under the contracts and allocating the income to the years in which it was actually earned. If the income from long-term contracts is computed in such a manner, all items of income and expense will be consistently accounted for upon the accrual basis, which will clearly and correctly reflect petitioner’s net income. But the Commissioner takes exception to this method of accounting for income derived from long-term contracts, on the ground that under most of these contracts the commissions or fees, representing the petitioner’s profits, were not due and payable until completion and acceptance of the work and could not be considered as income prior to the time they became due and payable. Wo think the manner of accounting for income from long-term contracts on the basis contended for by the petitioner is proper under the accrual method of accounting. The accrual method of accounting requires that at the end of every accounting period all income which has been earned during the period must be accounted for as income accrued in that period, though perhaps not collected, because it is not due and will not be collected until some future date. It contemplates that the income shall be determined on the basis of a fair distribution between the periods during which the income accrues. Under such a system of accounting a taxpayer accrues income, it does not receive it. Appeal of Clarence Schock, 1 B. T. A. 528. Accounting for the income on the basis contended for by the petitioner, the income from long-term contracts is apportioned between the taxable years in the same ratio that the work completed in each year bears to the whole, thus accruing the income in the years in which it was actually earned. It conforms entirely with the accrual method of accounting and, as we have said before, the accrual method will clearly reflect the petitioner’s net income.

Whether the so-called completed contract basis of accounting for income derived from long-term contracts is a proper basis for computing net income under the income tax acts is a question which it is not necessary for us to decide in disposing of the issue before us, and we express no opinion in respect thereof. Suffice it to say, that the petitioner’s books of account were not maintained upon the completed contract basis, as the Commissioner contends.

The petitioner’s net income for the years 1917 and 1918 should be computed in accordance with the accrual method of accounting, the income from long-term contracts being determined upon the basis that it accrued in the year in which it was earned according to the progress of the work, as evidenced by the expenditures under these contracts.

During the year 1918 the petitioner had a Government contract on which all work was stopped because of cancellation thereof on December 6, 1918. Owing to the inability of the United States Housing Corporation to determine certain adjustments in connection with the work which had been done, the profit could not be ascertained until some time in 1919. Pending the final determination of the profit from this contract, a lump sum of $82,000 was credited in 1918 to profit and loss for that year. When all adjustments and doubtful items had been settled in 1919, an additional amount of $14,061.91 was found to be due the petitioner. The petitioner contended that this item of $14,061.91 constituted income for the year 1918, and alleges error on the part of the Commissioner in failing to include the same in the net income of that year. The allegation of error is admitted by the Commissioner in his answer to the petition. The net income for the year 1918 should be increased by the sum of $14,061.91.

Judgment will he entered on 15 days’ notice, under Bule 50.


source: Caselaw Access Project

author: Lansdon:

license: Public Domain

text:
    J. T. Pittard, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 1804.
    Promulgated December 23, 1926.
    1. Value of farm land acquired by the petitioner prior to March 1, 1913, determined.
    2. Date of sale of real estate determined, and petitioner held entitled to return income therefrom on the installment basis.

      George M. Stanton, Esq., for the petitioner.

      Bruce A. Low, Esq., for the respondent.
    The Commissioner has asserted a deficiency in income tax for the year 1918 in an amount not disclosed by the record, but less than $10,000. The controversy arises from the Commissioner’s alleged error in the computation of gain realized from the sale of certain parcels of real estate.
    FINDINGS OF FACT.
    The petitioner is an individual residing at Winterville, Ga. During the year 1918 he sold 227.54 acres of land, which he had acquired prior to March 1,1913, for the amount of $8,532.75. In 1912 he sold 49.95 acres of land adjacent to the land in question and a part of the original tract which had included the acreage sold in the taxable year for $40 an acre, or a total of $2,000. The land sold in the taxable year had a fair market price or value of $37.50 an acre at March 1, 1913.
    In 1917 the petitioner and an associate purchased certain tracts of contiguous lands aggregating 898.7 acres, and paid therefor the amount of $35,751.20. On November 12, 1917, he sold 128.1 acres, one of the tracts so acquired to which he then held title in his own name, for $8,326.50, which he received in installments as follows: Date of sale, 10 per cent of purchase price, or $832.65; February 14, 1918, $1,667.35; May 22, 1919, $1,826.50; January 8, 1920, $4,000. The purchaser of this land, by virtue of a first payment and a contract for deed, entered into possession and use on November 12, 1917, and received a deed, subject to deferred payments, on February 14, 1918.
    Upon audit of the petitioner’s income-tax returns for the years 1917 and 1918, the Commissioner held that the tract of 227.54 acres acquired prior to March 1, 1913, and sold for $8,532.75 in 1918, had a fair market value or price of $30 per acre at March 1, 1913. In respect of the second transaction, he held that the sale was made on February 14, 1918, that the transaction was closed on that date, and resulted in taxable gain in the amount of the difference between the purchase and sales price of 128.1 acres included in the tract purchased for $35,751.20 in 1917.
   OPINION.

Lansdon:

The Commissioner has determined that the tract of 227.54 acres of land acquired by the petitioner prior to March 1, 1913, had a value of $30 per acre at that date. The evidence discloses that an adjacent tract of 49.95 acres of similar land was sold in 1912, or early in 1913, for $40 per acre. The petitioner testified that on account of nut grass infestation there was no increase in the market value of the land in question between March 1, 1913, and the date of sale. We have found that the value of this land was $37.50 per acre at March 1, 1913. No profit resulted from its sale in 1918 at the same price.

To redetermine the deficiency based on the profit realized from the second transaction, we must decide (1) whether this sale was made in 1917 or 1918, and (2) whether taxes on the income from such sale shall be computed by the installment method. The evidence shows that agreement between vendor and vendee was made on November 12,1917. On that date a contract to sell real estate was entered into, 10 per cent of the purchase price was paid to the vendor, and the vendee at once entered into possession. Deferred payments were provided for and made in terms set forth in our findings of fact above. We are of the opinion that this sale was effected on November 12, 1917, that the transaction provided for payment of the deferred amount of the purchase price in installments, and that the petitioner’s tax liability as to income resulting therefrom should be determined and computed on the installment basis, as provided for by law and the regulations of the Commissioner.

Judgment toUl be entered on 10 days’ notice, under Rule 50.


author: Smith:

text:
    National Sash & Door Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5788.
    Promulgated December 23, 1926.
    1. Auditors working on tbe petitioner’s books of account for tbe year 1018 discovered in May, 1919, that although there was no shortage in the cash account of petitioner as of December 31, 1918, Liberty bonds of the par value of $6,600 were missing in May, 1919, and in an audit of the petitioner’s books of account in October or November of 1919, discovered a shortage in cash as of October 22, 1919, of $13,441.80. After the correction of two minor adjustments the petitioner determined that it had sustained a loss through embezzlement of $19,464.01, which amount it deducted from gross. income in its income-tax return for the year 1919 as a loss sustained in the year 1919. In the audit of the petitioner’s return this loss was allowed as a deduction from the gross income of 1918 and disallowed as a deduction from gross income in the return for 1919. Held, upon the evidence, that the loss was sustained within the year 1919.
    2. Depreciation upon machinery was sustained at the rate of 10 per cent per annum for the years 1920 and 1921, instead of at the rate of 5 per cent per annum, as determined by the Commissioner.

      Morris B. Redmann, Esq., and O. G. Robinson, O. P. A., for tbe petitioner.

      M. N. Fisher, Esq., for the respondent.
    This is a proceeding for Die redetermination of deficiencies in income and profits tax for the years 1919,1920, and 1921, as follows:
    1919_$11, 828.28
    1920_ 6, 209. 94
    1921_-_ 2,081.98
    20,118.20
    The petitioner alleges error in the determination of the deficiencies as follows:
    (1) The disallowance, as a deduction from income in the calendar year 1919, of an item of $19,484.01, representing an embezzlement by an employee, based on the assumption that said embezzlement occurred in the year 1918.
    (2) The allowance of $4,490.38, $4,640.58 and $4,701.32 for depreciation on machinery for the years 1919, 1920, and 1921, respectively, instead of $8,980.76, $9,281.16 and $9,402.64 for the three years, respectively.
    FINDINGS OF FACT.
    The petitioner is a Louisiana corporation engaged in the business of manufacturing window sash, doors, etc. It had in its employ a man by the name of Loog, in whom the officers of the corporation reposed great confidence. Its books of account were regularly audited by a firm of certified public accountants for the years 1916 to 1921, inclusive. The audit of its books of account for the calendar year ended December 31, 1918, was made in May, 1919. This audit showed cash on hand at December 31, 1918, of $1,502.72. Cash in banks was verified by certificates from several depositaries and petty cash was verified by actual count as nearly as could be determined. The cash in the banks was found to be $945.14. The books of account at December 31, 1918, showed Liberty bonds, war savings stamps, etc., $34,468. The auditors, when they made their examination in May, 1919, could not then locate $6,600 of Liberty bonds. When Loog was questioned about them he stated he had turned them over to one Walker, an officer of a local trust company, for safe keeping. Walker told the auditors that he did not have them and that if he had received them for deposit he would have given a receipt for them. The auditors in their audit, dated June 3, 1919, stated to the petitioner:
    We duly examined all of these securities with the exception of the item of $6,600, which represents for the most part various issues of bonds bought in during the year from employees. We did not examine these bonds for the reason that your Mr. Loog was unable to locate same, although he has made several attempts to do so, and at this date they are still unaccounted for. We will strongly recommend that immediate steps be taken to settle the matter definitely as to whether these bonds are lost or not.
    Officers of the petitioner became suspicious of Loog when they learned in the fall of the year that he was betting on horse races. The firm of accountants which regularly did the auditing for the petitioner was immediately requested to make an audit of the petitioner’s books of account, and such audit was made as of October 22, 1919. This audit disclosed a shortage in the cash account of $13,441.80, which, after the adjustment occasioned by a, deduction of $577.79, showed an actual shortage in cash of $12,864.01 and in Liberty bonds, $6,600 — a total shortage in the amount of $19,464.01. Loog was immediately discharged by the petitioner, but owing to the fact that he was a man with a large family and had no property he was neither prosecuted nor sued.
    In its income-tax return for 1919 the petitioner claimed the deduction from gross income of $19,464.01 as a loss due to embezzlement. The Commissioner disallowed this deduction from the gross income of 1919, but amended the petitioner’s income-tax return for 1918 by allowing the amount as a deduction from the gross income of 1918.
    The petitioner operates a number of planing and mortising machines. The knives and “ heads ” of these machines, as well as the bearings, soon wear out. These may be replaced. There is considerable obsolescence in these machines. More efficient machines are developed from time to time and the experience of manufacturers in this line is that, on the average, it is unprofitable to operate machines which have been in use from 7 to 10 years. In most cases the machines are turned in for new machines within a period of from 7 to 10 years. In the determination of deficiencies for the years 1919, 1920, and 1921, the Commissioner allowed a deduction for depreciation and obsolescence in respect of the machines owned by the petitioner at the rate of 5 per centum per annum and disallowed the claim of the petitioner to a deduction for depreciation at the rate of 10 per centum per annum.
   OPINION.

Smith:

With respect to the embezzlement question involved in this proceeding, the only question is whether the loss was sustained within the year 1918 or 1919. The petitioner claimed the deduction from gross income of the year 1919. It had no knowledge that it had sustained any loss through embezzlement in the year 1918. It learned in May, 1919, that $6,600 of Liberty bonds were missing, and it further learned of a shortage in the cash account as of October 22, 1919. Certified public accountants who audited its books of account for the year 1918 did not discover any shortage in cash at December 31, 1918.

The evidence before us indicates that the embezzlement occurred in the year 1919. Upon the record it must be decided that the loss was sustained in the year 1919 and that the amount thereof is a legal deduction from gross income in that year.

The second question relates to the rate of depreciation sustained upon the woodworking machinery operated by the petitioner. An officer of the petitioner, who had had considerable experience with woodworking machinery of the character of that owned by the petitioner, testified that such machinery had a life of not to exceed 10 years and that it was the practice of such manufacturers usually to replace -worn machines by new machinery within a 10-year period. Upon the evidence it must be held that depreciation was sustained at the rate of 10 per cent, rather than at the rate of 5 per cent, as determined by the Commissioner.

Judgment will ~be entered on 15 days’ notice, wider Bule 50.


author: Arundell:

text:
    Holmes Ives, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5646.
    Promulgated December 23, 1926.
    1. Under the facts, held, that petitioner is entitled to charge off as bad debts ascertained to be worthless certain advances made in behalf of a corporation.
    2. Amount paid by petitioner to sales manager of a corporation of which petitioner was president held not deductible as a business expense.
    3. Amount spent by petitioner for extra copies of a magazine for distribution to employees of a corporation of which he was president held not deductible as a business expense.

      A. D. Duncan, Esq., for the petitioner.

      D. D. Shepard, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income tax for the calendar years 1921 and 1922 in the amount of $505.40. Only a part of the deficiency is in controversy, as the petitioner admits that deductions claimed in his returns for miscellaneous expenses in 1921 and club dues in 1921 and 1922 were improper deductions. The questions for decision are: (1) Whether the petitioner is entitled to deduct funds advanced in behalf of a corporation in 1921 and 1922; (2) the amount of salary received by the petitioner in 1922; (3) whether petitioner is entitled to a deduction of an amount spent for magazines for the use of employees of a corporation in 1921.
    FINDINGS OF FACT.
    The petitioner is an individual residing at Oakland, Calif. In 1921 he was president of the Silver Star Mining Co., a Nevada corporation capitalized at $1,000,000, with stock of the par value of $1 per share, of which the petitioner owned 1,000 shares, which was a part of the stock he received in exchange for mining claims located •in Nevada. The Nevada property of the company was managed by F. A. Evans.

      During the year 1921 the petitioner paid the manager Evans and deposited to the credit of the Silver Star Mining Co., subject to check by Evans, funds aggregating $1,959.47. These funds were used by Evans to pay expenses of developing the company’s mining claims. During the year the petitioner purchased for the company a tent at a cost, with shipping charges, of $27.15, and a truck at a cost, including accessories and freight charges, of $615. On November 18, 1921, he paid a mining geologist the sum of $277 to cover expenses of an examination and report on the mining claims of the company. These advances and payments in behalf of the company during the year, aggregating $2,878.62, were made by the petitioner from his personal funds.
    The mining geologist who examined the mining property of the Silver Star Mining Co. submitted to the petitioner a report dated October 22, 1921, wherein he concluded that the ore was confined to “ bunches ” too small to be profitably mined and advised against any further expenditures in the development of the claims.
    At the close of the year 1921 the Silver Star Mining Co. had no assets other than the mining claims, which were unpatented.
    On April 14,1922, the petitioner paid Evans the amount of $134.90, representing the balance due for services rendered and supplies furnished the mining company in 1921, and some time during the year he paid at least $700 for assessment work done on the mining property.
    The petitioner has not been reimbursed by the Silver Star Mining Co. for the expenditures he made in its behalf in 1921 and 1922. On August 20, 1924, a meeting of stockholders of the company was held at which there was authorized the issuance of 7 per cent notes to the petitioner for the funds he had advanced for the company. On the same date a directors’ meeting was held at which the action taken at the stockholders’ meeting was ratified. However, the notes were not issued, the petitioner being of the opinion that they would be of no value if they were issued. On July 20, 1925, a meeting of the directors of the company was held at which a resolution was passed instructing the treasurer to check the amount of the advances made by the petitioner and to issue to the petitioner the company’s notes for each year’s advances, including interest, attorneys’ fees, and costs, the notes to run for sixty days and to bear interest at 7 per cent until paid.
    In his income-tax returns for 1921 and 1922 the petitioner deducted as advances to the Silver Star Mining Co. the sums of $2,875.92 and $887.70, respectively. The deductions were disallowed by the Commissioner.

      The petitioner was one of the organizers of the Coast Tire & Eub-ber Co., a California corporation, organized in August, 1919, and-engaged in the manufacture of automobile tires and tubes. In 1921 and 1922 the petitioner was president and a director of the company and J. I. Pankratz was vice president and a director. Pank-ratz went to California at the suggestion of the petitioner and assisted in the organization of the corporation, later becoming its sales manager. It was understood between the petitioner and Pank-ratz that the latter would share equally with the petitioner in any proceeds from the company. In accordance with this understanding, the petitioner and Pankratz each received a portion of the original issue of stock and of a later increase in the stock. The company paid the petitioner a salary of $12,000 per year. Prior to 1921 Pankratz received no salary and the petitioner during that period gave Pankratz one-half of his salary, or $500 a month. For the years 1921 and 1922 Pankratz received from the company a salary of $10,000. In order to equalize their salaries for those years, the petitioner paid Pankratz for 1921 the sum of $1,066.68 by checks bearing various dates throughout the year, and for 1922 he paid Pankratz the sum of $1,000. In his income-tax return for 1922 the petitioner reported his salary as $11,000. The books of the Coast Tire & Eubber Co. show the petitioner’s salary for that year as $12,000, which is the amount of salary used by the Commissioner in his computation of the deficiency.
    In 1921 the petitioner purchased 48 copies of a certain issue of the magazine “ System,” in addition to his own subscription, at a cost of $12. That issue contained an article dealing with the administration of the Ford plant which the petitioner felt would be beneficial to employees of the Coast Tire & Eubber Co. to whom he distributed the 48 copies. The amount of $12 spent for magazines was claimed as a deduction by the petitioner as a business expense in his income-tax return for the year 1921, and was disallowed by the Commissioner.
   OPINION.

Arundell:

We are satisfied that the amounts advanced by petitioner to the Silver Star Mining Co. wore loans to that company and not further investments made by him as a stockholder. His stock ownership therein constituted less than one-tenth of one per cent of the outstanding stock. Being so convinced, it is not our province to inquire into the wisdom of the loan; it is only necessary for the petitioner to establish the fact that the amounts advanced were ascertained to be worthless and charged off within the taxable year. At the close of 1921 the corporation had no assets other than its mining claims, which were unpatcnted and held only by right of location. In October, 1921, a mining geologist rendered a report giving it as his opinion, after an examination, that the corporation’s mining claims could not be developed profitably. The petitioner testified that in the face of that report it would be impossible to raise money for the further development of the claims. Money spent to secure a judgment against the company under such circumstances would have been a useless expenditure. We feel satisfied that the petitioner has established the worthlessness of the debt in 1921, and it follows that he should be permitted to charge it off. The fact that he had hopes that some day something might turn up whereby he might recover the money is not sufficient to prevent the charging off of a debt which in fact was worthless in the taxable year. The amounts sought to be charged off in 1922 represented in part obligations incurred in the previous year, and the balance was to cover the assessment work necessary to hold the mining claims. As stated by petitioner, perhaps he was "sending good money after bad,” but we do not believe the deduction is to be denied because the taxpayer may not have exercised good business judgment. The amounts advanced in 1922 are proper deductions for that year. See Appeal of Midland Coal Co., 1 B. T. A. 311.

The evidence is clear that the petitioner received a salary of $12,000 from the Coast Tire & Bubber Co. for the year 1922. He accordingly erred in reporting only $11,000 of that amount. The question for decision is whether the amount of $1,000 turned over to Pankratz is an allowable deduction from the petitioner’s income. Testimony was offered to the effect that the $1,000 was paid in accordance with an understanding between the two that Pankratz was to share equally with the petitioner in any profits that might be realized from the venture of organizing and promoting the Coast Tire & Bubber Co. The two men had been friends for a number of years and -associated in business together before coming to California, and we believe these facts were the impelling motive that prompted the agreement for a division of the taxpayer’s income with Pankratz. Under such circumstances, we can not regard the amount claimed as an ordinary and necessary business expense.

The petitioner claims as a deduction for 1921 the amount of $12 which he spent for extra copies of a magazine containing an article on the administration of the Ford plant, which he distributed to employees of the Coast Tire & Bubber Co., of which he was an officer. We regard the expenditure as purely personal and not as an allowable business expense.

Judgment will be entered on 15 days' notice, wader Rule 50.


text:
    Pine Bluff Compress & Warehouse Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7989.
    Promulgated December 23, 1926.
    1. The installation of equipment that reduced competition and resulted in large profits is not an abnormal condition under section 327 (d) of the Revenue Act of 1918 requiring special assessment under section 328 of that Act.
    2. The evidence does not establish the existence of alleged abnormalities due to low salaries and the exclusion of earnings in prewar years from income lor those years lor purposes of computing prewar credit.

      Robert Walston Chubb, Eso., for the petitioner.

      Robert A. Littleton, Esq., for the respondent.
    This proceeding involves a deficiency of $6,373.73 in income and profits tax for the fiscal year ended August 31, 1919. Error is alleged for the reason that the respondent refused to compute the tax for the year in question under the provisions of sections 327 and 328 of the Revenue Act of 1918.
    FINDINGS OF FACT.
    The petitioner corporation was organized in March, 1912, to engage in the cotton warehousing and compressing business at Pine Bluff, Ark. The cotton buyers of that locality were responsible for its organization and they subscribed for and held practically all of its stock. At the time of its incorporation, there were two cotton compresses and storage plants at Pine Bluff. Both of these were owned by a Missouri corporation which operated a chain of such plants. The petitioner began its operation in a small way in 1912 in the face of strong competition. Its equipment at the beginning was limited to one shed, partly covered. From the date of organization to the end of the calendar year 1912, the business suffered a loss of $4,261, but during the next calendar year there was a net income of $9,670.53. Additions were made to the plant from time to time and the business growth continued from year to year.
    Some time prior to the fiscal year 1918-1919 (during 1917 or the first half of 1918), a sprinkler system was installed at a total cost of $100,144.26. This was the first sprinkler system installed in the State of Arkansas by a cotton compressing and warehouse company. The installation of the sprinkler system reduced the fire risk and benefited the petitioner in the following manner.
    The cost of fire insurance on its plant and equipment was reduced from $4,023.85 and $3,884.59 in the fiscal years ending in 1915 and 1916, respectively, to $3,204.17 and $2,121.76 for the fiscal years ending in 1917 and 1918, respectively. There was a corresponding reduction in the cost of fire insurance of persons storing their cotton in petitioner’s warehouse. By reason of this reduction in fire insurance premiums, the inducement to do business with the petitioner was increased and competition reduced, and the sprinkler fee charged persons patronizing the petitioner became an added source of income. The taxable income of the petitioner increased from $27,112.08 for the calendar year 1917, and $18,034.05 for the first eight months of 1918, to $55,985.08 for the fiscal year in question, which was the first full year of operation with the sprinkler system. A portion of this increase and taxable income was due to a 50 per cent increase in compressing fees which took effect in the summer of 1918.
    The original paid-in capital of the petitioner amounted to $38,900, and by April, 1919, by the issuance of various stock dividends, the total issued capital stock amounted to $195,000, and at the-close of the fiscal year ended August 31, 1919, there was a net deficit in surplus of $38,862.62.
    The officers of the petitioner consisted of the president, vice president and secretary-treasurer. From the date of incorporation through the year in question, the president and secretary-treasurer devoted a part of their time to the affairs of the petitioner, being paid nominal salaries in the early years of the corporation’s life, and salaries totaling $1,200 for the fiscal year in question. Three hundred dollars was paid to the secretary-treasurer as a salary during the year in question. The president of the petitioner was instrumental in organizing the corporation and during the fiscal year in question his stockholdings amounted to approximately 750 shares out of a total of 8,000 shares then outstanding of the par value of $25 per share. The president of the petitioner was instrumental in seeing that the business of the petitioner was operated in an efficient manner and that all necessary economies were practiced in the conduct of the business. He owned other businesses, including a wholesale grocery business located at Pine Bluff, Ark., and was engaged in the business of buying and selling cotton, with offices in Pine Bluff and Little Bock, Ark. The secretary-treasurer’s stock-holdings during the year in question amounted to approximately 1,400 shares. In the early years of the petitioner’s life, he supervised the maintaining of books of account of the petitioner without compensation, and as the accounting and bookkeeping needs of the petitioner increased in later years, and during the fiscal year in question, there were employed assistants to perform the detail work, leaving only the broad supervisory work to the secretary-treasurer. In addition to the services rendered petitioner, he was also engaged in operating a plantation in the State of Arkansas. During the taxable year in question petitioner paid wages and salaries to others than officers totaling $74,800.
    When cotton was placed in storage the charges made for handling, storage, and compressing of the cotton were not collected until the cotton was shipped upon order of the owner. The petitioner maintained its books of account during the years 1912 and 1913 upon the cash receipts and disbursements basis, and storage charges on cotton placed in storage prior to the end of each year and remaining in storage until after that date were not reflected on petitioner’s books or in its earnings. The audit of the revenue agent, upon which the deficiency in question is based, and which audit was introduced in evidence by the respondent, without objection, states that the petitioner was organized in March, 1912, and in computing the war-profits and excess-profits taxes for the fiscal year in question, determines the prewar credit allowable under section 310 of the Revenue Act of 1918, as follows:

   OPINION.

Milliken:

The petitioner alleges abnormalities within the meaning of section 327 (d) of the Revenue Act of 1918. That subdivision, so far as pertinent to this appeal, provides :

Where upon application by the corporation the Commissioner finds and so declares of record that the tax if determined without benefit of this section would, owing to abnormal conditions affecting the capital or income of the corporation, work upon the corporation an exceptional hardship evidenced by gross disproportion between the tax computed without benefit of this section and the tax computed by reference to the representative corporations specified in section 328. This subdivision shall not apply to any case (1) in which the tax (computed without benefit of this section) is high merely because the corporation earned within the taxable year a high rate of profit upon a normal invested capital, * * *.

The conditions which the petitioner contends bring it within the purview of this subdivision are as follows:

1. Installation of sprinkler system in its plant prior to the taxable year, which resulted in unusual profits within the year.

2. Low salaries paid to its officers during the fiscal year.

3. The income for prewar years was abnormal as 1912 was the year of organization and, as the cash receipts and disbursements basis was used in reporting income for the year 1913, income actually earned was not reflected.

The grounds upon which the petitioner requests consideration under sections 327 and 328 of the Revenue Act of 1918 will be discussed in the order named.

1. In the findings of fact we have set forth in some detail the advantages resulting from the installation of the sprinkler system. There is no doubt that such installation reduced competition in the vicinity in which petitioner operated and that the same was largely responsible for profits earned during the fiscal year in question. It is manifest, however, that it was not the intent of Congress to give relief, by means of special assessment, to a taxpayer solely on the ground that it earned large profits. There is no contention that the invested capital of the petitioner can not be satisfactorily determined, and it is admitted that petitioner took and has been allowed adequate depreciation during the fiscal year in question on the sprinkler system installed. The installation of the sprinkler syétem did not create an unusual condition affecting either income or capital and resulted in no abnormality justifying consideration for special assessment.

2. The second alleged abnormality affecting net income is that the income of the petitioner is increased for the period in question by reason of low salaries paid to its officers. We have no evidence before us as to whether the salaries paid by the petitioner were lower than those paid by representative concerns engaged in the same line of business, and the Board is not in possession of information which would enable it to determine whether the salaries paid were lower in comparison with salaries paid by similar concerns. This is not a case where all the stock was owned by members of a family, as in Appeal of Yale Brevda Paper Box Mfg. Co., 2 B. T. A. 900, or where all the stock was owned by the officers of the corporation, as in Appeal of Sol Frankel, Inc., 3 B. T. A. 494. In the case at bar the officers owmed approximately 25 per cent of the stock of the petitioner and the salaries may have represented what the corporation determined to be adequate for services rendered. It is to be noted from the findings of fact that the president of petitioner was actively engaged in conducting the affairs of two other concerns. He devoted only a part of his time to the conduct of the affairs of the petitioner. In addition the petitioner paid wages and salaries to other than officers totaling $74,800 during the period in controversy. The secretary-treasurer, who owned 1,400 shares of stock, devoted only a part of his time to the affairs of the petitioner, and it is set forth in the findings of fact that his duties for the years in question were only supervisory and that he was also engaged in the operation and management of a plantation during the fiscal year in question. The petitioner also had a vice president, but the record is silent as to his duties or the salary paid him during the year in question. For the several reasons given we must conclude that the petitioner’s claim on this point does not represent an abnormality justifying consideration under sections 327 and 328 of the Revenue Act of 1918.

3. The petitioner alleges an abnormality in the determination of prewar income. The period from March, 1912, to the close of that calendar year can not be considered in connection with determination of prewar net income, as it is clearly eliminated as a prewar year by the express terms of section 310 of the Revenue Act of 1918, which provides as follows:

That as used in this title the term “ prewar period ” means the calendar years 1911, 1912, and 1913, or, if a corporation was not in existence during the whole of such period, then as many of such years during the whole of which the corporation was in existence.

See also article 771 of Regulations 45.

It will be observed that the plain words of the statute permit us to treat only the year 1913 as a prewar year in the instant case. With respect to the calendar year 1913, the petitioner claims that charges actually earned within that year were not included for the reason that the charge earned on certain cotton in storage during that year was not collected until after the close of the year and was not included in the income for the calendar year 1913 because the books of account were maintained upon a cash receipts and disbursements basis. No basis other than a cash receipts and disbursements basis was permitted for the computation of income during the year 1913, and the prewar years are calendar years by express statutory enactment. Nor, in the instant case, are we informed as to what charges earned during the calendar year 1912 are included in the income for the calendar year 1913, so that perchance the charges for 1912 paid in 1913 may have a compensating effect for charges earned in the year 1913 and paid in the year 1914, and that such compensating effect may remove any abnormality that existed in income for the year 1913. Under such a state of facts we can not assume abnormality existed for the prewar year justifying consideration for special assessment.

As set out in the findings of fact, the audit, upon which the deficiency in question is based, shows the corporation was organized in March, 1912, yet it takes one-half of the net income of 1913 to determine the allowable prewar credit. In view of the provisions of section 310, such a computation is erroneous and should be corrected to show a prewar credit in the amount of $9,670.53.

Judgment will be entered on 15 days’ notice, wider Bule 50.


author: Murdock:

text:
    Appeal of H. J. Schlesinger.
    Docket No. 6339.
    Promulgated December 23, 1926.
    Deductions allowed under section 214(a) of tbe Revenue Act of 1921, but not connected with tbe trade or business regularly carried on by tbe taxpayer and not specially considered in tbe method of calculation of tbe “net loss,” as set out in section 204(a) of tbe same Act, must be subtracted from tbe total deductions allowed under section 214(a) before tbe calculation is made, so that tbe result of tbe calculation will be tbe “ net loss ” defined in section 204(a) of tbe Act.

      Charles F. Fawsett, Esq., for the petitioner.

      Robert A. Littleton, Esq„, for the Commissioner.
    A deficiency of $344.09 individual income tax for the year 1923 resulted from the Commissioner’s reduction of the petitioner’s 1922 loss in applying section 204 of the Revenue Act of 1921, as interpreted by article 1601 of Regulations 62.
    FINDINGS OF FACT.
    The petitioner in the year 1922 had a gross income of $127,876.27. Of this amount $49,107.30 was income derived from a trade or business, and $78,768.97 was derived from sources not connected with a trade or business. His deductions under section 214(a) of the Revenue Act of 1921 amounted to $168,943.39. Of this amount $77,874.10 was deducted for expenses of the business (farming) regularly carried on by the taxpayer, $82,312.82 was deducted for taxes (inheritance) paid, $6,998.60 was deducted for interest paid (not connected with the business of farming), and the balance, $1,757.81, was deducted as a loss (not sustained in farming).
    In computing the tax upon the income for the year 1923 the Commissioner refused to allow a net loss for the year 1922 under the provisions of section 204(a) of the Revenue Act of 1921.
   OPINION.

Murdock:

We are satisfied that article 1601 of Regulations 62 is not in accordance with section 204(a) of the Revenue Act of 1921, because the article gives a double effect to deductible losses not sustained in a trade or business regularly carried on by the taxpayer. This double effect is not authorized or intended under section 204(a). The difficulty, however, is to make a calculation which is in accordance with this section and which will stand the- test in every case. If there is a possible interpretation of the Act which will give effect to the intent of Congress, of course it is our duty to adopt such an interpretation.

This section of the Act reads as follows:

Sec. 204. (a) That as used in this section the term “net loss” means only-net losses resulting from the operation of any trade or business regularly carried on by the taxpayer (including losses sustained from tbe sale or other disposition of real estate, machinery, and other capital assets, used in the conduct of such trade or business) ; and when so resulting means the excess of the deductions allowed by section 214 or 234, as the case may be, over the sum of the following: (1) the gross income of the taxpayer for the taxable year, (2) the amount by which the interest received free from taxation under this title exceeds so much of the interest paid or accrued within the taxable year on indebtedness as is not permitted to be deducted by paragraph (2) of subdivision (a) of section 214 or by paragraph (2) of subdivision (a) of section 234, (3) the amount by which the deductible losses not sustained in such trade or business exceed the taxable gains or profits not derived from such trade or business, (4) amounts received as dividends and allowed as a deduction under paragraph (0) of subdivision (a) of section 234, and (5) so much of the depletion deduction allowed with respect to any mine, oil or gas well as is based upon discovery value in lieu of cost.

In the first part of the section Congress said that “ net loss ” means only net losses resulting from the operation of any trade or business regularly carried on by the taxpayer. In the latter part of the same section Congress indicated a calculation or a method of arriving at such net loss, “ when so resulting.” By this method Congress indicated, among other things, the effect which it intended that deductible losses not sustained in such trade or business, and taxable gains or profits not connected with such trade or business, should have upon the net loss resulting from the operation of the trade or business regularly carried on by the taxpayer. Bear in mind that in this case we are concerned with an individual, and as deductible losses not sustained in such trade or business are included in the deductions allowed by section 214, and, as taxable gains or profits not derived from such trade or business are included in gross income, “ (3) ” of the method indicated in the section of the Act so functions or operates that, should the taxable gains or profits not derived from such trade or business exceed the amount of the deductible losses not sustained in such trade or business, the “ net loss ” will be decreased in the exact amount of the excess, and, where that excess is greater than the loss from the operation of the business, there will be no “ net loss.”

Thus “ (3) ” carries out the intent of Congress in regard to losses deductible under section 214(a) but not connected with the trade or business of the taxpayer. As a result of it a net loss from the operation of a trade or business regularly carried on by the taxpayer may never be increased by deductible losses outside of that business, but will be decreased by any excess of outside profits or gains over de-duetible losses sustained outside of such business; “ (2) ” functions in much the same way in regard to certain interests; “ (4) ” and “ (5) ” serve a similar purpose in regard to other deductions. But what is the situation in regard to that portion of the taxes deductible under section 214(a) (3), of the debts deductible under section 214 (a) (7), of the contributions or gifts deductible under section 214(a) (11), and of any other deductions under section 214(a), which the section 204(a) calculation does not obviously take care of — all of which deductions are in no way connected with the trade or business regularly carried on by the taxpayer? We are speaking about that portion only of these deductions which is in no way connected with the taxpayer’s regular trade or business.

One interpretation of section 204(a) would be to consider “ deductions ” and “ déductible losses ” as equivalent. If we can do this, the method prescribed in the Act is all-inclusive, and in every case will determine whether or not there is a “net loss,” if the indicated calculation is made. The difficulty which arises when there are taxes, debts, contributions, etc., not connected with the business is thus avoided because they are deductions equivalent to deductible losses and under “ (3) ” are given the effect which Congress intended they should have upon “net loss.”

Our objection to this solution is that it does not give any effect to the words when so resulting,” which appear in this section of the Act. It holds that the “ net loss,” as defined in the first clause of section 204(a), will be determined in every case if the calculation in the remainder of section 204(a) is carried out. It assumes that the Act would have been just the same if the words “ when so resulting ” had been omitted. If deductible losses are equivalent to deductions, why did Congress deem it advisable, when framing this section of the Act on deductions, to mention, in addition to three kinds of losses, taxes, debts, and contributions? We think that taxes, debts, and contributions, which may be deducted under section 214(a), are essentially different from any losses deductible thereunder and are not losses in any sense of the word. Another objection is apparent in the instant case, where this interpretation would allow the taxpayer a net loss of $28,766.86, which would have been decreased and wiped out by an excess of taxable gains outside of the regular business over outside losses had it not happened that in this particular year this taxpayer paid a large inheritance tax which, as a “ deductible loss,” stepped in and prevented the cancellation. Considering the whole section, we do not think that such was the intent of Congress.

There is another and more reasonable interpretation which avoids these absurdities and gives meaning to the words “ when so resulting.” In it we hold that the specific provisions of the calculation indicated in the latter part of the section are only applied in any given case in connection with the general provisions of the definition in the first part of the section, and it is only after consideration of both of these parts of the section that we get the true “ net loss ” as intended by Congress. The remainder of section 204 is inapplicable if the “ net loss ” results from something other than the operation of such trade or business. We do not assume that deductible losses and deductions are equivalent. Deductible taxes, debts, and contributions not connected with the trade or business regularly carried on by the taxpayer will not receive consideration under “ (3),” and it is apparent that they will not be given any effect at any other place in the prescribed calculation. However, it does not follow that the effect upon “ net loss,” which Congress intended they should have, can not be given by the application of a common sense rule.

When a net loss is claimed and when, and only when, there are losses shown on the return from the operation of a trade or business regularly carried on by the taxpayer, we first subtract from the deductions allowed by section 214(a) those portions of taxes, debts, gifts, and contributions, which have no connection with the business but which are included in the total deduction, and then proceed with the calculation indicated in section 204(a) to arrive at the “net loss.” Effect has thus been given to all parts of the section. If the return does not show a loss from the operation of a trade or business regularly carried on, then there can be no net loss, and it makes no difference that the entire return may show a loss, since we are not concerned with that loss which may have resulted from the deduction of taxes, debts, and contributions not connected with the regular trade or business, deductible losses not sustained in such trade or business in excess of taxable profit not derived from such trade or business, interest, or from some other deduction.

Under this interpretation it will be noted that the excess of taxable gains or profits outside the business over deductible losses outside the business decreases and, if large enough, wipes out the loss from the business regularly carried on, and it is not prevented from so doing by the fact that in the same year the taxpayer may have paid an inheritance tax, charged off bad debts, or made gifts or contributions all of which were deductible, but had no connection with the trade or business regularly carried on. _ This is the only case in which this interpretation gives a different result from the interpretation which we first discussed.

When there are losses shown on the return, we must first inquire whether these losses are the net losses defined in the first part of section 204(a), or whether they are due to the deduction of taxes, debts, or contributions which had no connection with the business. If it appears that the losses are due entirely to the deduction of such taxes, debts, or contributions, we have arrived at the answer to our problem, which is that there is no “ net loss.” In some close cases it may be necessary to eliminate these taxes, debts, gifts, and contributions and then to apply the calculation indicated in the Act to see if there is a “ net loss.” These taxes, debts, gifts, and contributions can be subtracted from the deductions allowed by section 214(a) before the calculation is made or subtracted afterwards from the answer. In either case the result is the same. We think that this interpretation is reasonable and that it carries out the intent of Congress. If there is a net loss resulting from the operation of any trade or business regularly carried on by the taxpayer, that net loss is determined by this method. If the loss as shown by the return results from something other than such trade or business, by this method no “ net loss ” results.

In the instant appeal the petitioner’s loss was partly due to the payment of an inheritance tax of $82,312.82. If he had not paid this inheritance tax in this particular year he would not have had a “ net loss ” for the year 1922, and therefore in this case it is not necessary to make the calculation, but if the calculation is made the result is the same — there is no “ net loss.”

The reason that the petitioner does not have a “ net loss ” is that the loss which resulted from his farming operations was overcome and wiped out by the excess of his taxable gains outside of that business over his deductible losses outside of that business. It is a mere incident that in this year he paid inheritance taxes, and Congress never intended, by section 204(a) of the Revenue Act of 1921, that a loss in one year due to such a cause should be carried over as a net loss in the following yeár.

Jvdgment will be entered for the Commissioner.

Tkussell dissents.


author: Littleton:

text:
    Buffalo Forge Co. and Buffalo Steam Pump Co., Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3170.
    Promulgated December 23, 1926.
    1. Expenditures over the years 1909 to 1913 properly applicable to the cost of perfecting and developing a patent determined and allowed as a deduction from the sales price of the patent in 1917 for the purpose of determining the gain or loss upon such sale.

      2. Interest paid by a subsidiary upon its indebtedness to tbe parent should be excluded as a deduction by the subs'diary and from income of the parent, in determining consolidated invested capital for the purpose of the 1917 excess-profits tax, and the amount of the indebtedness of the subsid.ary to the parent in excess of the amount of the indebtedness on which it was entitled to deduct interest paid for income-tax purposes under Title I of the Revenue Act of 1917 was not a proper item to be included in computing consolidated invested capital.

      H. A. Mihills, G. P, A., for tlie petitioners.

      L. L. Hiffht, Egq., for the respondent.
    The Commissioner determined deficiencies in income and profits taxes in the amounts of $30,870.06 and $75,203.07 for the calendar years 1917 and 1918, respectively, and $5,011.57 for the eleven-month period ending November 30, 1919.
    The issue relating to the deduction for amortization of war facilities for 1918 and 1919 having been eliminated by stipulation, the petitioners claim, first, that the Commissioner erred in his determination of a profit of $95,000 on the sale for $115,000 in 1917 of the English rights to certain patents acquired prior to March 1, 1913, and certain improvements thereon; secondly, that the Commissioner erred in deducting from the consolidated net income for excess-profits-tax purposes for 1917 the amount of $3,218.88, representing interest paid by the Buffalo Steam Pump Co., a subsidiary of the Buffalo Forge Co., in excess of the amount of the interest which the Buffalo Steam Pump Co. was entitled to deduct in determining net income under section 12(a) Third of the Revenue Act of 1916, as amended by section 1207 of the Revenue Act of 1917, and that the Commissioner should have included in consolidated invested capital the amount of $70,802.04, representing the amount of the indebtedness of the Buffalo Steam Pump Co. to the Buffalo Forge Co. on which the former was not entitled to deduct interest paid.
    FINDINGS OF FACT.
    The Buffalo Forge Co., hereinafter referred to as the petitioner, and its subsidiary, the Buffalo Steam Pump Co., are New York corporations with principal office at Buffalo.
    In 1887, William S. and Henry W. Wendt, brothers, formed a partnership and began the manufacture of heating and ventilating apparatus, portable forges, drills, punches, shears, and blowers. In 1901 the business was incorporated and in 1905 the company acquired the Buffalo Steam Pump Co., which was engaged in the manufacture of similar articles.

      The petitioner’s operations were originally commenced under a patent, and a number of inventions were subsequently developed and patented. No separate cost records were ever maintained with respect to experimental and development work in connection with these various patents. Labor and material costs, as well as all expenses, were absorbed in general operating costs, no portion thereof being capitalized upon the books of account.
    In 1907, James H. Van Deventer, an experienced mechanical engineer, became associated with the petitioner as general superintendent. Soon thereafter he conceived -the idea of a compact spiro turbine engine, having one or more pairs of rotors, each having a plurality of spirally disposed and intermeshing tooth blades and propelled by steam, compressed air, or fluid. In the latter part of 1908 the petitioner acquired the necessary tools and materials and began the development of this device through the manufacture of models. Applications for letters patent were promptly filed and patents were granted by Great Britain on May 25, 1911, and by the United States on June 27, 1911. During 1909 two men in addition to Yan Deventer and Weidenbach, superintendent of the tools shops, who devoted a great deal of their time to this work, were employed exclusively in the work of developing this invention. The cost hereinafter shown for materials and labor in the perfection and development of the spiro turbine engine includes only compensation paid to workmen engaged exclusively in the development of this patent and does not include any compensation for Van Deventer or Weidenbach, nor does it include any amount paid for draftsmen, pattern makers, or to any one whose time was not devoted exclusively to the development of this invention.
    During the years 1909 to 1913 petitioner expended for materials, labor and experimental work in perfecting and developing the spiro turbine engine a total of $61,850, as follows:

    The manufacturing or overhead expense, not including administrative, general or selling expense, represented an average of 61.8 per cent of the total labor for the years 1909 to 1913. The total cost of labor included in the development cost of the patented spiro turbine was $54,060, to which should be added $33,742.80, representing overhead expense properly allocable to the development of this invention computed upon the basis of 61.8 per cent. The total cost of the patent was therefore $95,592.80.
    The patent granted in 1911, which covered the principle of the spiro turbine engine, was assigned by Van Deventer to the petitioner. Thereafter, between 1911 and 1913, patents on improvements were granted on applications of Van Deventer, as assignor to the Buffalo Forge Co.
    In 1912 various experiments and tests as to the use of the spiro turbines in the operation of coal-cutting machinery and for other purposes were made and the invention was found to be thoroughly practicable and efficient, particularly in the operation of coal-cutting machinery in use in the coal mining industry. In that year the petitioner acquired information as to the probable demand existing in the English market for an engine of this type in the operation of coal-cutting machinery in the gaseous mines of that country. The first engine under this patent was sold in January, 1913, for $400. Subsequent sales were made at $350 each. The cost of producing the engine was approximately $175, so that upon each engine sold a profit of approximately $175 was realized. The sales of the spiro turbine engine in 1913 amounted to $1,775, and the sales gradually increased thereafter with the result that in 1917, when the English rights under the patents were sold, the annual sales amounted to $90,000. Practically all sales had been made to American concerns who, in turn, sold the engine in the English market. No sales of the spiro turbine engine were made by the petitioner from the date of the sale of the English rights of the patents to and including 1920. One thousand and fifty dollars was received from the sale of parts. In computing the gain upon the sale of the English rights under the patents, the Commissioner determined that the patent had no fair market price or value on March 1,1913. However, the Commissioner deducted from the sales price the amount of $20,000, representing an expenditure by the petitioner in 1917 in clearing the title to the British patent, thereby determining a profit of $95,000 upon the sale of the patents in 1917 for $115,000.
    The Commissioner disallowed a deduction from, 1917 taxable income of $3,218.88, representing interest for that year upon $70,802.04, the excess of the indebtedness of the Buffalo Steam Pump Co. to the petitioner upon which it was entitled to a deduction for interest paid under section 12 (a) Third of the Revenue Act of 1916, as amended by section 1207 of the Revenue Act of 1917. In determining the consolidated net income for the purpose of the excess-profits tax, the Commissioner deducted therefrom the above mentioned amount of $3,218.88 and declined to include in the consolidated invested capital the amount of $70,802.04.
   OPINION.

Littleton:

Petitioner claims (1) that the fair market price or value of the English rights of the patent on March 1, 1913, was $150,000, and that it therefore derived no taxable gain from the sale thereof in 1917; (2) that in the event the Board does not agree with it as to the March 1, 1913, value, the cost of $95,592.80 properly applicable to the development and perfection of the patent should be considered and deducted from the sales price in determining gain or loss in 1917.

Considerable testimony was given as to the probable future earnings anticipated on March 1, 1913, from the sale of the patented spiro turbine engine, predicated primarily upon information, which has not been shown to have been very definite, as to the probable number of engines that petitioner might be able to sell for shipment into England. The Board is unable to make a finding that the patent had a fair market price or value on March 1, 1913.

The evidence as to the amounts expended between 1909 and 1913 in perfecting and developing the patent is clear and convincing, and we are satisfied therefrom that the petitioner expended for materials and labor properly applicable to the work of perfecting and developing this patent the amount of $95,592.80, as hereinbefore set forth. This amount, less proper exhaustion from the date of expenditure at the rate of one-seventeenth per annum from 1911, should therefore be deducted from the sales price in 1917 in addition to the $20,000 allowed by the Commissioner.

In determining consolidated net income for 1917 for the purpose of the income tax, the Commissioner disallowed as a deduction $3,218.88, representing interest on $70,802.04, the amount in excess of the limitation of indebtedness for which the Buffalo Steam Pump Co., subsidiary, could deduct interest under the provisions of section 12 (a) Third of the Revenue Act of 1916, as amended by section 1207 (1) of the Revenue Act of 1917. This disallowed interest was paid to the Buffalo Forge Co., parent. In determining consolidated net income for excess-profits-tax purposes under section 206 pf Title II of the Revenue Act of 1917, the Commissioner deducted therefrom the amount of $3,218.88, the excess of the interest allowable as a deduction under Title I of the Revenue Act of 1916, as amended by the Revenue Act of 1917. The petitioner claims that this action of the Commissioner was incorrect under the provisions of section 206 (c), Title II, of the Revenue Act of 1917, and that the excess interest of $3,218.88 should not have been deducted from consolidated net income for invested capital purposes, but that the amount of $70,802.04, the indebtedness of the Buffalo Steam Pump Co., subsidiary, on which it was not entitled to deduct interest paid to the parent company, should have been included in computing the consolidated invested capital for the taxable year 1917 under the provisions of article 44 (b) of Regulations 41.

In the opinion of the Board the determination of the Commissioner in respect of this issue was correct. All interest paid by the subsidiary to the parent was an intercompany transaction which had no effect upon consolidated net income for excess-profits-tax purposes. Neither was the excess indebtedness of $70,802.04 of the Buffalo Steam Pump Co., subsidiary, to the Buffalo Forge Co., parent, a proper item to be included in consolidated invested capital. Appeals of Gould Coupler Co., 5 B. T. A. 499; Farmers Deposit National Bank, 5 B. T. A. 520; Ruckman Coal Co., 5 B. T. A. 534; H. S. Crocker Co., 5 B. T. A. 537.

Judgment will be entered on 15 days' notice, under Bule 50.


text:
    Appeal of James C. Murphy and Mercantile Trust & Deposit Co. of Baltimore, Executors, Estate of John H. Windfelder
    Docket No. 4166.
    Promulgated December 30, 1926.
    Common-law doctrine of estates by tlie entirety obtains in Maryland, and upon the death of one spouse there is no transfer of any part of such estate to the survivor; hence there is nothing upon which to impose an estate tax under the Revenue Act of 1921.

      Jo'hnF. Grea/ney, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in estate tax under the Revenue Act of 1921, in the amount of $445.43, of which only a part is in controversy. The question presented by the case is whether the value of real estate, owned by the decedent and his wife as tenants by the entirety at the time of decedent’s death, should be included in the gross estate of decedent for estate-tax purposes. The facts were stipulated.
    FINDINGS OF FACT.
    John H. Windfelder died on April 5, 1923, leaving a will which was duly admitted to probate, and the executors who bring this appeal were appointed by the Orphans’ Court of Baltimore City, Md.

      In May, 1912, Amalia H. Windielder, wife of the decedent, took title to property known as 121 Hawthorne Road, Roland Park, Md., which she thereafter held until about January 9, 1923, when title was taken in her name and the name of the decedent as tenants by the entirety, the title being so held at the time of the death of the decedent.
    The executors of decedent’s estate duly filed an estate-tax return. The Commissioner added to the gross estate reported in the return the value of the property hereinbefore mentioned.
   OPINION.

Arundell:

The Commissioner admits that the title to the land here involved was held at the time of the death of the decedent by the decedent and his wife as tenants by the entirety.. While it would seem, therefore, to be unnecessary to make any determination as to the status of such titles in the State of Maryland, we will, in order to make ourselves perfectly clear on the subject, give briefly what we have found with respect to tenancies by the entirety.

Article 5 of the . Constitution of Maryland provides that the common law shall obtain in that State subject to modification or repeal by the State legislature. From the decisions of the Maryland courts it would seem that the common-law doctrine of estates by the entirety has never been changed by the statutes of the State. In McCubbin v. Stanford (1897), 85 Md. 378; 37 Atl. 214, it is stated,

Tlie common law on this point [estates by the entirety] has never been changed in this state. Marburg v. Cole, 49 Md. 411.

In Brewer v. Bowersox, 92 Md. 567; 48 Atl. 1060, after stating the common-law reasons underlying an estate by the entirety, the court says:

This estate, with its incidents, continues in Maryland as it existed at the common law. [Citing McCubbin v. Stanford, supra.] It differs materially from all other tenancies. The right of survivorship, which is one of its chief incidents, cannot be destroyed, except by the joint act of the two, and upon the death of either the other succeeds to the entire property or fund.

In Ades v. Caplan (1918), 132 Md. 66; 103 Atl. 94, 95, we find this statement:

Tenants by the entireties are, in the contemplation of the common law, which is the law of this state, but one person, and hence they take, not by moieties, but the entirety. They are each seized of the entirety, and the survivor takes the whole. Marbury v. Cole, 49 Md. 411, 33 Am. Rep. 266.

In the case of Safe Deposit & Trust Co. v. Tait (U. S. Dist. Ct., District of Maryland, Dec. 19, 1923), 295 Fed. 429, it is said:

A tenancy by the entireties is created by a conveyance to husband and wife, whereupon each becomes seized and possessed of the entire estate, and after the death of one the survivor continues to take the whole.

In view of what we have said so far as to estates by the entirety in Maryland, the decision in this case is governed by that in Appeal of Susie M. Root, 5 B. T. A. 696, holding that in the State of Missouri, where the common-law doctrine as to such estates obtains, there is no transfer of interest or estate to the survivor on the death of either spouse, hence there is nothing upon which to impose a tax.

At the hearing counsel for the Commissioner pointed out that title to the property here involved was taken by decedent and his wife as tenants by the entirety after the Revenue Act of 1921 was enacted, and contended that by reason of that fact the decision in Blount v. United States, 59 Ct. Cls. 328, was not applicable to the present case. In that case the grant of the estate by the entireties took place prior to the enactment of the statute under which the additional tax was asserted. We considered the same distinction in Appeal of Root, supra, and held that—

In our opinion the fact that the conveyance of the land in question nere was made to H. L. Root and his wife subsequent to the enactment of the Revenue Act of 1921 does not alter the case.

The Commissioner contends that the wife acquired the property involved in 1912 as a gift from her husband and that therefore the property does not come within the exception set forth in section 402(d) of the Revenue Act of 1921. We do not believe that we need consider the method by which the wife acquired title to the property. Our only concern here is as to the manner in which the property was held at the time of death of the decedent. To determine this, in the absence of fraud or attempted evasion of taxes, we need go back no further than the acts or instrument of January 9, 1923, which placed the title in decedent and his wife as tenants by the entirety.

Judgment will l>e entered on 15 days’ notice, under Rule 50.


author: Trussell:

text:
    American Show & Entertainment Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7679.
    Promulgated December 30, 1926.
    Deductions foe altekations and kepaibs. — Evidence respecting the nature and purpose of various items of building alterations and repairs examined and certain items held allowable deductions for losses and repairs.

      Frank Garitón, Esq., for the petitioner.

      W. H. Lawder, Esq., for the respondent.
    The petitioner has complained of a deficiency letter dated August 8, 1925, asserting deficiencies in income and profits taxes for the year 1920 in the amount of $855.14, and for the year 1921 in the amount of $2,141.64.
    The only issue presented for our consideration is whether certain expenditures in and about the petitioner’s building were capital expenditures or repair expenditures.
    FINDINGS OF FACT.
    The petitioner is an Illinois corporation with its principal place of business at Chicago. In 1910 it leased certain premises for a period of 34 years, and, under the terms of the lease, erected thereon a building constructed of steel and tile. The side walls were finished with plaster and the outside with stucco. The building was constructed for a dance hall and is approximately 200 feet long by 100 feet wide, with a stage at one end and an arch roof 48 feet high.
    The items in dispute for the year 1920 are as follows:
    The taxpayer purchased and installed over its stage a curtain and valance at a cost of_$1,300.00
    It purchased and installed three electric dryers at a cost of__ 100.00
    And it expended for stage scenery and decorations_ 1,080.00
    These items were charged to expense in the year 1920. The curtain and valance were discarded during the year 1921. The dryers proved unsatisfactory and were discarded during, the year 1920. The stage scenery and decorations had a life of a year or more. The Commissioner restored all of these items as capital expenditures. During the year 1921 the petitioner made a general reconditioning of its building and in so doing expended a total of $45,968.38 for materials and labor. It charged $23,160.10 of this amount to capital and $22,808.28 to repairs. Of the items charged to repairs the Commissioner disallowed the following:
    Frescoing and decorating_ $5,000.00
    Changes in heating system— 1, 963. 62
    Changes in plumbing and tile 675. 00
    Plaster work-898. 98
    Lumber used-1, 616.42
    Labor of carpenters-1,058.23
    Changes in stage settings_ 2, 023. 80
    Miscellaneous iron work_ 824.00
    Miscellaneous alterations-
    16,151.55
   OPINION.

Trussell:

At the trial of this proceeding much testimony was produced respecting the petitioner’s property, its generally rundown condition, and the necessity for the changes and alterations which were made.

Officers of the petitioner corporation, and a capable architect employed by it to superintend the alterations and changes made, testified in detail in respect to all of such alterations and changes and the expenditures for such purposes.

Upon all the evidence contained in this record respecting the several items claimed by the petitioner as repair expense and disallowed by the Commissioner, we are of the opinion that of the three items disallowed for the year 1920 the item of cost of electric dryers, $100, which were installed and discarded during the same year, should be allowed as a deduction from gross income for that year. Of the several items disallowed by the Commissioner for the year 1921 we are of the opinion that the testimony supported the claim of the petitioner in respect to the following items:

Changes in heating system-$1, 963.62
Plaster work_ 898. 96
Changes in stage settings- 2, 023. 83
Miscellaneous alterations- 2, 091. 52
Total_ 6, 977. 93

and that these items should be allowed as repair expenses for the calendar year 1921.

The deficiencies will he recomputed in accordance with the foregoing opinion pursuant to Bule SO, and judgment will he entered th&reon accordingly.


text:
    Redlands Security Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5703.
    Promulgated December 30, 1926.
    Rates of depreciation to be used or to be considered in determining gain resulting from sale of orange orchards determined.

      Halsey W. Allen, Esq., for the petitioner.

      D. D. Shepard, Esq., for the respondent.
    The Commissioner has found a deficiency in income and profits tax for the year 1920 in the amount of $808.57. The controversy arises from the Commissioner’s computation of profits realized by the petitioner in the sale of certain lands with orange groves thereon. The questions at issue are (1) the correct method of computing gain or loss on the sale of depreciable property acquired before March 1, 1913, and sold .subsequently thereto, and (2) the reasonableness of the rate of animal depreciation on orange groves used by the Commissioner in computing the petitioner’s tax liability.
    FINDINGS OF FACT.
    The petitioner is a California corporation, with its principal office at Redlands. In 1910, at a cost of $75,000, it acquired an orange grove, consisting of 60 acres fully planted with trees, which at that time were three years old. The maturity of these trees was retarded two years by a freeze that occurred in January, 1913. The parties agree that the value of such orange grove at March 1, 1913, was $48,000, which the Board finds was its value at January 1, 1914.
    In the year 1915 the petitioner acquired 400 acres of land at a cost of $70,000. Included in this land was an orange grove of 10 acres, which was three years old at that date. The grove had a value at date of acquisition of $800 per acre.
    In the year 1920 the petitioner sold both tracts, the first for $72,000, and the second for $70,000. In its income and profits-tax return for 1920 the petitioner reported no gain from these transactions. Upon the audit of such return, the Commissioner computed accrued depreciation on the 60-acre grove from March 1, 1913, to the date of sale in the amount of $9,840, which he added to the sale price for the purpose of computing the gain on the transaction, and thereby determined a profit from the sale of such grove in the amount of $6,840. In the same audit he determined that the value of the 10-acre grove was $8,000 at the date of its acquisition in 1915, and computed accrued depreciation thereon to the date of sale in the amount of $1,080, which he added to the sale price of the entire tract of 400 acres, and thereby determined a profit from the second transaction in the amount of $1,080.
    The parties agree that the average producing life of this orange grove is 30 years. The average time between planting and production is 6 years.
   OPINION.

Lansdon:

The parties agree that this orange grove is a depreciable asset. It follows, therefore, that the owner of such a grove is entitled to deduct annually from gross income a reasonable allowance on account of depreciation, which must also be included as a factor in computing the gain or loss resulting from the sale of such property. The Commissioner properly considered accrued depreciation of the petitioner’s orange groves at the date of sale as an element in computing gain or loss resulting from such sale. Appeals of Even Realty Co., 1 B. T. A. 355; J. J. Gray, Jr., 2 B. T. A. 672; Walter Frank, 2 B. T. A. 905.

In the instant proceeding the Commissioner holds that the useful life of an orange grove is 30 years, and computes depreciation on the grove of 60 acres acquired by the petitioner in 1910 and sold in 1920 by applying an annual depreciation rate of 3y3 per cent to the value of such property at March 1, 1913, which was $48,000, and, in the same manner, determines accrued depreciation at date of sale of the 10-acre grove acquired in 1915 and sold in 1920. Obviously, these computations are based on the theory that each of the groves had reached the point where it was producing income at the basic dates. The petitioner agrees that the useful life of an orange grove is 30 years, but contends that such useful life begins at the date when the grove becomes an income-producing property. The parties appear to agree that after planting there is a period of some years during which there is no depreciation. The Commissioner contends that this period is not more than 3 or 4 years from the date of planting the trees in the grove. The petitioner introduced evidence that convinces us that this development period is not less than 6 years.

The grove of 60 acres acquired in 1910 was seven years old at March 1, 1913, but the evidence discloses that its maturity had been delayed for at least two years by a heavy frost or freeze that occurred in January of 1913. We are of the opinion that this grove was not a depreciable asset prior to the crop year of 1915, and that computation of gain or loss resulting from the sale thereof at February 1, 1920, should include depreciation from that year. The grove of three-year old trees acquired in 1915, which, we have found, had a value at that date of $8,000, could not have become a depreciable asset prior to 1918. The rate of exhaustion on both orchards was 3½ per cent per annum.

Judgment will be entered on 20 days’ notice, under Rule 50.