author: Littleton:

text:
    F. Burkhart Manufacturing Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5294.
    Promulgated January 13, 1928.

      Abraham Lowenhaupt, Esq., for the petitioner.

      Henry Rrnenel, Esq., for the respondent.
   OPINION.

Littleton:

The question here at issue is the extent to which the petitioner is entitled to an amortization allowance under the provisions of section 234 (a) (8), Revenue Act of 1918, on certain buildings constructed during 1918 and 1919 for the production of articles contributing to the prosecution of the war. When the Commissioner made an examination of petitioner’s claim in 1923, he found that the buildings in question were being used to their full capacity in the petitioner’s regular business and disallowed the entire claim in so far as it related to the buildings, on the ground that their value to the petitioner in its business precluded such an allowance. The petitioner admits that the buildings were in full use at the time of the respondent’s investigation and that they were then necessary in its regular business, but contends that neither the cost of reproduction nor their value in use subsequent to the war has any bearing upon the amortization deduction. The position of the petitioner is that the amount of the amortization deduction is either (1) the cost of the facilities or (2) the cost of the facilities less what they would have cost in normal times preceding the war.

The argument advanced by the petitioner in support of a deduction of the entire cost during the period of war operation is that Congress enacted the amortization provisions for the purpose of permitting taxpayers who made expenditures on account of war facilities to write off the entire cost against war operations and thus exempt their profits from tax to that extent, regardless of the value of the property at the close of the war or the use made of it thereafter. In other Avords, that this allowance was intended in the nature of a bonus granted to persons engaged in Avar activities; that not only Avas the taxpayer to be saAed from any losses suffered because he could not make full use of the facility after the close of the Avar, but also Avas to be placed in a position where such part of the assets which remained of value to him after the war would effectually be extinguished or wiped off his books as a deduction against war income. This, the petitioner says, necessarily folloAvs from the definition of the word “ amortize ” which Webster’s Dictionary defines as meaning : “ To extinguish; to make as if dead; destroy; to clear off, liquidate, or otherwise extinguish, as a debt, usually by a sinking fund.” That is to say, a reasonable allowance for amortization could only be one which would deaden or extinguish the entire cost.

The foregoing construction of the part of the statute here in question is not only contrary to decisions of this Board, but also is inconsistent Avith the amortization section, as we understand it, when taken as a Avhole. In one of the first cases involving an amortization allowance Avhich came before the Board, Appeal of Banna Manufacturing Co., 1 B. T. A. 1037, we said:

Taxpayers who produced articles contributing to the prosecution of the late war and who, on or after April 6, 1917, erected, installed or acquired buildings, machinery, equipment or other facilities for that purpose, are entitled to deduct from gross income, under section 284 (a) (8) of the Revenue Act of 1918, the difference betAveen the cost of such buildings, machinery and equipment, and their actual sale price or fair market value when discarded, with proper allowance for depreciation while used, or, if they are still in use, their value to the taxpayer in terms of their use or employment in its going business.

This was folloAved by other decisions in Avhich the Board stated that the purpose of the amortization allowance was to permit a deduction against Avar profits of extraordinary expenditures for property for war purposes which the taxpayer would find useless upon the termination of the war. In the Appeal of Walcott Lathe Co., 2 B. T. A. 1231, the Board said:

The purpose of the high rates was, in effect, to confiscate so-called war profits and to prevent the making of extortionate profits from the war, but it was recognized that in many cases facilities had been provided for the production of articles for war use which would be useless, or nearly so, upon the termination of hostilities. Manifestly, the cost of such facilities could not be regarded as recoverable over a long life of wear and tear, but could be regarded as recoverable only against the articles which that capital was invested to produce. In other words, the extraordinary investment on account of war facilities was properly recoverable out of war profits, and Congress in sections 214 (a) (&) and 234 (a) (8) so provided.

In the same opinion, it was further stated:

Reverting also to the purpose of the amortization provisions, it is clear that Congress intended that taxpayers should be permitted to eliminate from their capital accounts as an expense of producing war articles the cost of the capital assets provided for that purpose which became useless thereafter.

That the Board has not departed from the foregoing conception of the amortization provision is shown by the following statement from the recent opinion in John, Polachek, 8 B. T. A. 1:

The amortization deduction, so far as can be ascertained from the meager legislative history open for our consideration, was enacted not because it was believed an essential factor in the determination of income, but rather because it was believed to be a fair, even though extraordinary, method of reducing tax. It is plain that income is not normally affected by an inflated capital cost, whether attributable to war or otherwise. Section 215 (b) expressly prohibits the deduction of such capital outlay. Normally such capital investment is kept unimpaired by taking from net income annually, through allowance for exhaustion, wear and tear and obsolescence, an amount sufficient to aggregate its cost at the end of its life. As to the war facilities, however, the taxpayer who had invested extensively was permitted something greater than this in an effort to relieve him from an unbalanced investment incurred during the war and beyond his peacetime needs. As said in Walcott Lathe Co., supra., this extraordinary deduction was actuated by a purpose to afford relief from the high taxes of the war period and was in its nature something different from the usual depreciation deduction.

And further in the same opinion, the Board stated with respect to the meaning of the word “ amortize,” as follows:

Some point is made that the word “amortize” itself connotes a period of years, which is inconsistent with the application of the deduction to a single year. The word is not so definitive, and, since the broad terms of the statute necessarily require interpretation, the word must be applied in consonance with the statutory intendment as we understand it. So long as there are cases where the period of war production, war income, or other war circumstances, extends beyond 1918 (cf. Standifer Construction Corporation, supra), so that the deduction may be spread, the word fits the purpose. The petitioner’s contention would require that in no case could the deduction be confined to a single year, a view which, as we have seen, would more often defeat the statutory deduction than afford the intended relief. The word is sufficiently adapted to the remedy provided so that it may apply, as the statute says, to “ the year or years affected.” A reasonable deduction may, under the circumstances of each case, be either spread over a period or confined to a single year. The facts here indicate no reason for a spread.

In view of the foregoing, there could hardly be any question that the interpretation previously given by the Board to the amortization provisions is opposed to the first proposition advanced by the petitioner. The Board is also of the opinion that the arguments advanced by the petitioner fail to take full cognizance of the intent indicated by statements made in Congress when this war measure was being enacted. While such discussions are not controlling as showing the meaning of a given act, they at least are helpful in seeking to determine the underlying purpose. Mr. Kitchin, Chairman of the Ways and Means Committee, on September 3, 1918, in making the report to the House on the Revenue Act of 1918, made the following comment with respect to the amortization provision (65th Cong., 2d sess., H. Rept. No. 767):

(4) Due to the necessity for erecting buildings and building machinery for war purposes many buildings and much machinery have been erected that will be of little value after the war. Under existing law it is impossible for the Treasury Department to allow deductions other than for the ordinary exhaustion, wear and tear, and depletion of such property. A provision is incorporated in this bill to .allow the Treasury Department in such cases to allow special amounts for amortization, according to the peculiar condition in each case, but such amounts can not exceed in any year 25 per cent of the net income. At any time within three years the allowance may be reexamined, and if found incorrect the taxes will be readjusted, and any overpayment refunded or any underpayment collected from the taxpayer.

With some minor changes, the same provision came up for consideration before the Senate when, during the discussion, the following statement was made (Congressional Record, February 17, 1919):

If by reason of the investment of his profits in an extension of his yards, the shipowner has constructed a plant which was necessary in time of war to meet the demands which were made upon him at that time for production, but which after the termination of the war has depreciated in value because not needed; in that case under the amortization provisions he will be allowed to amortize to the full extent of the depreciation in value.

In each instance the understanding appears to have been that some form of relief was being considered on account of expenditures which were made for war facilities which would be of no value upon the termination of the war or at least would have much less value in the business because unsuited to a given taxpayer’s peace-time needs. As we said in John Polachek, supra, “The statute was designed to give relief and not to confer bounty.” This same fact is further indicated by the provision for a later examination of the petitioner’s return for the purpose of determining as a result of an “ appraisal or from other evidence ” the correctness of the allowance previously made. If the total costs are to be allowed as deductions during the war year, we fail to see why it should be necessary to resort to an appraisal in order to determine the allowance. Webster’s Dictionary defines an “ appraisal ” as an “Act of appraising; appraisement; valuation; estimate,” and Bouvier’s Law Dictionary, vol. 1, p. 217, gives the meaning of the word “ appraise ” as “ To value property at what it is worth.” It certainly would be unusual to value subsequent to the war period to determine how much had been expended therefor, though an “ appraisal ” of property does have a definite meaning in the statute when considered with respect to a determination of the postwar value of property which a taxpayer had theretofore acquired for war work.

In view of the foregoing, the Board is of the opinion that the construction of section 234 (a) (8), Revenue Act of 1918, contended for by the petitioner, which would grant to it an amortization allowance of the total coste of war facilities regardless of their subsequent use or value to him, must be denied.

Secondly the petitioner concedes that although some of the discussion in Congress, while the provision here in question was being considered, may be opposed to the proposition heretofore disposed of, it contends that neither such discussion nor the Act itself is opposed to the alternative position taken, namely, that the amortization allowance is the excess of cost of the war facilities over normal cost, meaning by normal cost,” costs as prevailing during 1911, 1912, and 1913, rather than costs prevailing during the postwar period from the termination of the war to March 3, 1924.

The question concerning the proper allowance for amortization of facilities purchased for the production of articles contributing to the prosecution of the war, but which had some value to the taxpayer upon the termination of the war because they were continued in use in its business, has been before the Board on other occasions and then decided in a manner contrary to the construction contended for by the petitioner. While in the many cases heretofore considered, an alternative to the views which we have already expressed may not have been advanced by one of the several prior petitioners on this subject in the manner now advanced by the present petitioner, at any event, it became necessary in those cases to determine the amount of the deduction to which the petitioner was entitled, which included a decision as to the factors entering into such a determination. In Standard Refractories Co., 6 B. T. A. 24, in which many of the prior decisions bearing on the question here in issue were quoted with approval (Banna Manufacturing Co., supra; Kirk Coal Co., 3 B. T. A. 755; Greenville Coal Co., 3 B. T. A. 1323; and Manville Jenckes Co., 4 B. T. A. 765), the petitioner contended, among other things, for a deduction upon the basis of a comparison of the physical use during the postwar period with the physical use during the war period. In denying an allowance on this ground alone, the Board said:

Undoubtedly this is a factor whicli should be considered in determining what amount should be allowed as a reasonable deduction for amortization, but at best it is but one of the several factors. The cost of replacement during the postwar period, of the same or other facilities which would produce the same results; any improvements or radical changes in the facilities; the salvage value of such facilities; their selling price if they have been sold; a proper discount for excess facilities which may be used because they are on hand but which in the ordinary conduct of the business would have been acquired only in the future; and all other similar factors, depending upon the facts in the particular case, must be considered in determining the amount of the deduction. (Italics supplied.)

A positive statement from the Board as to the period to be considered in determining the extent to which a taxpayer has suffered by reason of an acquisition of a facility for war purpose and use of the same facility in peace-time operations is found in Manville Jenckes Co., supra, in which, after reviewing the pertinent provisions of the Revenue Act of 1918 and the changes made therein by the Revenue Act of 1921, the following definition of such period is given:

It would seem clear from the above-quoted provisions of the Revenue Act of 1921 that Congress, by implication at least, has fixed the termination of the postwar period in every case as March 8, 1924, and that it intended that the determination of the amortization deduction should be made in the light of all the conditions and circumstances surrounding a taxpayer’s business during the period intervening between the date of the termination of the war and March 3, 1924. Doubtless Congress realized that for the purposes of proper administration of the amortization provisions of the statute a line would have to be drawn somewhere; and we have no doubt that it intended that the circumstances peculiar to each taxpayer’s business during a definitely stated period, a period which would be the same in all cases, should be a determinative factor.

From the foregoing decisions made on this subject, the Board has certainly decided that the useful value of the property to the petitioner in its business must be considered in determining the amortization allowance on facilities which were continued in use after the termination of the war, and that such value must be predicated upon conditions and circumstances prevailing between the close of the war and March 3, 1924. We are of the opinion that an amortization allowance determined in this manner follows both the letter and spirit of the statute and gives to a taxpayer the reasonable deduction contemplated. To follow petitioner’s theory would make it necessary to determine the allowance by a comparison of prewar prices with war costs without regard to the extent to which a given facility is used after the war; that is, it leaves out of account excess facilities which may be retained by the taxpayer either for part-time or emergency operations. Of course, in this particular case where the facilities were being used 100 per cent, it would be advantageous to petitioner to have the deduction determined on its theory, but there are many cases where this would not be true. When a taxpayer is allowed a deduction from war profits for expenditures made for war purposes, but which had a lowered value to him in peace-time operations, substantial relief is being granted; but when a deduction is permitted on the petitioner’s contention, what amounts to a bonus is being meted out.

In disposing of the first contention advanced by the petitioner, we referred to the provision in the statute for a reexamination of a taxpayer’s claim when, “ as a result of an appraisal or from other evidence,” the correctness of the allowance previously granted might be determined. Again, we are of the opinion that the language here used evidences an intent on the part of Congress that all factors which would enter into such a determination must be considered;, not only those which existed when the return was filed, but also those which may become known by the end of the postwar period, which we have held to be March 3, 1924. If, as this petitioner contends, we are to consider only prewar prices as compared with war cost, it would hardly be necessary to resort to an appraisal for that purpose, for at least such prices would be as capable of determination at the time of filing the return or making the first examination as at some later time. We are of the opinion that when Congress referred to a reexamination of the return, it could only have had in mind a redetermination based upon postwar prices, conditions and circumstances which were changing in such a manner during the postwar period as to affect the measure of relief to be granted and not a redetermination based upon factors which were fixed at the termination of the war.

The foregoing does not mean that a determination of the amortization allowance based on value of the property to petitioner in its business is to be predicated only on the extent to which the facilities are used, the basis apparently followed by the respondent’s engineer who examined this claim, but all factors are to be considered which are indicative of an unbalanced investment made during a time of war prices for facilities which are being used in whole or in part in peace-time operations. This conception of the measure of relief to be granted is supported by Elliott v. United States, 16 Fed. (2d) 164. In the instant case we must sustain the determination as made by the respondent for the reason that insufficient- evidence has been presented by the petitioner which would justify us to overturn it.

Judgment will be entered for the respondent.


source: Caselaw Access Project

author: Milliken:

license: Public Domain

text:
    S. W. Parish, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9504.
    Promulgated January 13, 1928.

      E. F. Zwwwalt, O. P. A., John A. Timer, Esq., and Richard K. Bridges, Esq., for the petitioner.

      Bruce A. Low, Esq., for the respondent.
   OPINION.

Milliken:

The issues in this proceeding are: (1) Whether petitioner was in receipt of a dividend of $10,000 in the year-1919, and also of a dividend of the same amount in the year 1920; (2) whether petitioner is entitled to deduct from his gross income for 1920, the remaining half of the operating losses incurred by the partnership composed of himself and Ellis, and also the total amount paid by petitioner in said year in settlement of certain liquidating losses of the partnership; and (3) whether the fraud penalty provided by section 250(b) of the Revenue Act of 1918 should be imposed. •

With respect to the first issue, respondent contends that since petitioner rendered no service to the corporation, the resolution of April, 1919, should be construed as providing for a distribution of profits, and, therefore, anything credited to petitioner thereunder should be considered in the nature of a dividend. How he would apply tire credits to the other officers, who did perform services, is not explained. Without deciding this question, it is sufficient to point out that petitioner was on a cash receipts and disbursements basis, and, further, that there is no evidence to the effect that these two amounts were credited to petitioner in 1919 and 1920, respectively, on the boobs of the corporation. The accountant, who reconstructed the books, does not appear to have relied on any book entries made in said years, since the boobs which recorded items of this character were lost, but on the resolution of the board of directors. Even if these amounts had been credited to petitioner during the respective years involved, he would not, under the facts as found, have been taxable thereon as income then received, since he was on a purely cash basis. See Edmund J. Karr, 2 B. T. A. 635; M. E. Farr, 3 B. T. A. 110; and Charles F. Pearce, Jr., 6 B. T. A. 450.

Next, respondent contends that since it appears from the books, as reconstructed, that petitioner owed the corporation for stock, and since under the resolution he was apparently entitled to the bonus for each year and since the bonus was in the year 1922 credited as of the years 1919 and 1920 against such alleged indebtedness, it follows that petitioner was in the receipt of said amounts as of the date he should have received them. The major premise for this conclusion is that petitioner was indebted to the corporation for a balance due on his stock. This he denies and his denial is borne out by tine fact that the corporation issued to him for his share in the partnership, fully paid up and nonassessable shares. The fact that the value of the assets of the partnership may have been less than the par value of the stock issued therefor gave neither to the corporation nor to the other stockholders, all of whom participated in the transaction, an enforceable demand against petitioner. Cook on Corporations, (8th ed.), secs. 38 and 39. The most that can be said of the book entries made in 1922, is that they constituted an adjustment in that year of the capital stock and surplus accounts, which in no way created taxable income. Cf. Eisner v. Macomber, 252 U. S. 189; 3 Am. Fed. Tax Hep. 3020, and Michaels v. McLaughlin, 20 Fed. (2d) 959; 6 Am. Fed. Tax Rep. 6892. Whatever may have been the present effect of the entries made in 1922, such entries could not, under the facts of this proceeding, create taxable income to petitioner in 1919 and 1920. On this point, petitioner is sustained.

Whether petitioner is entitled to take as a deduction the whole of the operating loss of the partnership existing between him and Ellis, and also the whole of the amounts paid by him in the liquidation of that partnership, depends, first, on whether there existed between him and Ellis an agreement to the effect that petitioner was to bear all the partnership losses, and, second, on whether his claim for reimbursement was worthless in 1920. On the first point petitioner testified as follows:

Q. Let me ask you this, Mr. Parish: Did you know the financial condition of Mr. Ellis at the time you formed this partnership with him?
A. I did.
Q. What was it?
A. He did not have anything.
Q. Did you have any specific agreement at that time — anything at all about losses?
A. I did not.
Q. You stated to the Court that you were to stand the losses. Why did you say that?
A. Yes; I understood that I would stand the losses, because he did not have any money.
By the Member:
Q. Was that because he did not have the money or because you and he agreed to it — which?
A. It was understood that I would stand the losses, because he did not have any money.
Q. Was that the reason lor it?
A. Yes, sir.
Q. Or did you start out with that definite agreement?
A. Well, that was the agreement.

This testimony is not sufficient to show that the partnership agreement provided that petitioner was to bear all of the losses of the partnership. There remains the question whether petitioner’s claim for reimbursement was worthless in 1920.

It is shown that Ellis had an accident policy for $5,000. To whom this policy was payable is not shown, nor is it shown that petitioner could not have participated in its proceeds. It is further shown that on the date of the death of Ellis, which occured in June, 1920, the firm owned oil and gas leases and that subsequent to that date, petitioner paid as rentals on such leases the sum of $2,630.59. While it is true that petitioner testified that it was his impression that all the leases lapsed in 1920, we can not, in the face of the fact that during and after June, 1920, petitioner paid rentals thereon, hold that petitioner’s claim was worthless or was ascertained to be worthless during that year. The action of respondent in this respect is approved.

Since respondent did not deem it proper to impose the fraud penalty provided by section 250(b) of the Bevenue Act of 1918, prior to the taking of the appeal in this cause, and presented this claim for the first time at the conclusion of the evidence, in the shape of an amendment to his answer, the burden rests upon him not only to prove that petitioner omitted income from his returns, but that petitioner was guilty of fraudulent concealment. This latter element, we are of the opinion, respondent has failed to prove. It is shown that subsequent to the making of his returns, petitioner furnished a revenue agent with a paper similar to an amended return, which contained the items of income which had been omitted in his original returns and the report of the revenue agent, which was filed in evidence, discloses that he treated this paper as a return. We are of the opinion that the evidence produced by respondent is not sufficient to justify the imposition of the fraud penalty.

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


author: Trammell:

text:
    Coatesville Boiler Works, Petitioner, v. Commissioner of Internal Revenue, Respondent. Coatesville Boiler Works, Petitioner, v. Commissioner of

      Walter Biddle Saul, Esq., and J. A. LamoreTle, Esq., for the petitioner.

      D. D. Shepard, Esq., for the respondent.
   OPINION.

Trammell:

The principal issues involved herein may be divided into three groups of two each. The first group comprises the questions (1) whether the petitioner is entitled, in computing its taxable income for the fiscal year ended in 1917, to deduct as a business expense the amount of $54,845.99, paid to its officers and employees during that year as additional compensation for the fiscal years ended in 1915 and 1916, and (2) whether petitioner is entitled, in computing its taxable income for the fiscal year ended in 1918, to deduct as a business expense the amount of $51,326.18, paid to its officers and employees during that year as additional compensation for the fiscal year ended in 1916.

The second group comprises the questions (1) whether petitioner is entitled to have included in its invested capital for the fiscal year 1917, the amount of $106,172.17, part of which was credited to its officers as additional compensation and part of which was set up as a contingent fund, both amounts being charged against surplus prior to the beginning of that year, and (2) whether petitioner is entitled to include in invested capital for the fiscal year 1918, the amount of. $51,826.18, being the amount remaining in the contingent fund at the beginning of that year.

The third group comprises the questions (1) whether petitioner is entitled to include in its invested capital for the fiscal years and period in question, the depreciated cost of plans, drawings, and tracings used in its business, and (2) whether it is entitled to include in invested capital for said fiscal years and period the depreciated cost of its pattern account. In connection with these principal issues, several minor or preliminary issues arise.

The only issue involving the calendar year 1920 relates to the profits tax insofar as it is affected by the reduction of invested capital on account of the deficiencies determined for the prior years. At the hearing, the parties stipulated that proper adjustments to invested capital for all years would be made on the basis of the deficiencies finally determined for the prior years. It is unnecessary, therefore, to give further consideration here to the deficiency for the calendar year 1920.

The issues raised with respect to the fiscal years ended in 1917 and 1918, and the three-month period ended December 31, 1918, will be considered in the order hereinbefore indicated.

During the fiscal year ended September 30, 1917, the petitioner paid to its officers and employees, on the dates and under the circumstances detailed in our findings of fact, sufra, the total sum of $54,845.99 as additional compensation for the fiscal years 1915 and 1916. During the fiscal year ended September 30, 1918, petitioner paid to its officers and employees the total sum of $51,326.18 as additional compensation for the fiscal year 1916. Thus, during the fiscal years 1917 and 1918 petitioner so paid the aggregate amount of $106,172.17.

Petitioner contends that it kept its books of account on the basis of cash receipts and disbursements, and that, in computing its net income for each of said fiscal years, it is entitled to deduct as a business expense the amount so expended in each year, respectively. The respondent refused to allow the deductions claimed, or any part thereof, for the fiscal years 1917 and 1918, on the theory that the petitioner kept its books on the accrual basis, should have accrued said amounts in the fiscal years 1915 and 1916, and should have taken the deductions for those years.

The first question presented in this connection, therefore, concerns the basis upon which the petitioner kept its accounts, that is to say, whether petitioner kept its accounts upon the basis of cash receipts and disbursements, or “upon any basis other than that of actual receipts and disbursements.” The record contains no suggestion that the method actually used by the petitioner in keeping its accounts does not clearly reflect its income, and hence under the statute its tax must be computed upon its net income ascertained in accordance with such method.

The petitioner contends that, during the years here involved it kept its books of account and computed its net income on the basis of cash receipts and disbursements, while the respondent contends that the petitioner kept its books, computed its net income and made its tax returns on the accrual basis.

We have found, as set out in our findings of fact hereinabove, that the petitioner kept its books of account substantially on the accrual basis during the taxable years and period involved, although minor items of deferred charges and credits may not have been accrued. This conclusion is reached on the evidence in the record before us, which shows that in determining the cost of goods sold, the petitioner took into consideration opening and closing merchandise inventories; that goods were sold on credit, the amount being credited to sales and debited or charged to accounts receivable; that when payments were made on accounts receivable, suéh accounts were credited accordingly and the amounts debited or charged to cash; that when an account receivable was found to be uncollectible, the amount was charged as a loss and a deduction therefor taken in the petitioner’s tax return. The books also included accounts payable, and notes receivable and payable, and such items were given consideration in computing net income.

In considering a similar situation in Bartles-Scott Oil Co., 2 B. T. A. 16, wo said:

Tile first question — that of whether the taxpayer kept its books of account on an accrual basis — is not difficult of solution. We found as a fact, above, that the taxpayer carried inventories and notes and accounts receivable and payable on its books, and in determining its income these items were given consideration. In view of these facts we can not hold otherwise than that the taxpayer ojieratod on an accrual basis. The mere fact that some deferred charges and credits to income may not have been included in the accounts carried can not destroy the principle upon which the system of accrual bookkeeping is based.

See also John F. Cook, 4 B. T. A. 916.

At the hearing, after the introduction of considerable evidence tending to show that the petitioner kept its books on the accrual basis, counsel for the petitioner sought to show that its books were in fact kept on a sort of hybrid basis, or partly on the basis of cash receipts and disbursements and partly on the accrual basis, because of the fact that certain minor items consisting of interest, taxes, insurance and work in process were not accrued. However, we are not convinced by this evidence that the method of accounting regularly employed by the petitioner in keeping its books was not fundamentally the accrual method. The evidence as a whole shows that the petitioner kept its books and computed its income on the accrual basis. The fact that some deferred items were not accrued may indicate defective bookkeeping, but can not change the fundamental basis upon which the books were kept.

The evidence also shows that the respondent, in determining the deficiencies involved herein, computed the petitioner’s net income by the accrual method. Since that method appears in any event to approach more closely the predominating method employed by the petitioner, the action of the respondent in so computing the net income must be approved. Maine Dairy Co., 4 B. T. A. 375.

Having determined that the petitioner kept its books of account and computed its net income by the accrual method, it follows that the amounts in controversy constitute lawful deductions from income only for the year or years in which the liability therefor was incurred. In order that an item may be accrued, the liability must actually be incurred in the taxable year. William J. Ostheimer, 1 B. T. A. 18.

A deduction can not be taken for a year in which the liability was not incurred. Rex Machinery & Supply Co., 3 B. T. A. 182.

When was the liability here incurred ? A careful consideration of all the facts and circumstances set out in our findings of fact, supra, leads us to the conclusion that petitioner incurred the liability in 1915 and 1916 to pay the respective amounts authorized for those years.

The facts show that the additional compensation in question was authorized by the directors’ resolution of 1904, which was ratified and confirmed by the resolution of the stockholders of May, 1915. The services were rendered and the obligation to pay in accordance with the resolution became final. Just prior to the close of the fiscal year 1915, the amounts authorized for that year were formally accrued on the petitioner’s books, and at that time there was no legal obstacle to the payment of the money.

With respect to 1915, therefore, it is our opinion that the petitioner incurred liability to pay the aggregate amount authorized for that year on September 14, 1915, when the amount was ascertained and entered upon the books.

On September 14, 1916, the amounts authorized for the fiscal year 1916 were accrued on the petitioner’s books, although litigation was pending at that time and payment could not be made because of the stipulation entered into to prevent the issuance of an injunction. However, in determining the year for which a deduction may be taken by a taxpayer on the accrual basis, the date of the actual payment is immaterial.

And with respect to 191G, it is our opinion that the petitioner incurred liability to pay the aggregate amount authorized for that year on September 14, 1916, when the amount was ascertained and entries were made on the books, notwithstanding litigation was then pending, which, at some time in the future, might or might not have the effect of defeating that liability in whole or in part. The corporation did not deny the liability, but contended at all times that it was legally responsible for the compensation. The litigation was instituted by a minority stockholder to prevent the corporation from paying the compensation agreed to be paid. The court of last resort in 1917 upheld the corporation and held that the compensation should be paid for that year in accordance with the resolution. The decision of the court, however, did not create the liability to pay. That liability existed by virtue of the fact that the corporation had agreed to pay and the fact that the services were rendered. The corporation itself had never denied its liability which existed in 1916. The court merely affirmed the action of the corporation. See Percy K. Hexter, 8 B. T. A. 888.

For the foregoing reasons we are impelled to conclude that the petitioner did not incur any liability with respect to the amounts in controversy during either of its fiscal years ended in 1917 or 1918, and is not entitled to a deduction of any amount from the income for those years on that account. Accordingly, the action of the respondent in denying the deductions claimed by the petitioner for 1917 and 1918 is approved.

The issues of the second group relate to the inclusion in invested capital of the amounts credited to the accounts of the officers and employees, and the amount credited to the contingent fund, on the books of the petitioner during the fiscal years 1915 and 1916. Of the total credits in the amount of $125,924.37, the amount of $19,752.20 was held by the courts not to be payable, and on August 20, 3917, this amount was charged against the officers’ accounts and credited back to surplus. The respondent included in the computation of the petitioner’s invested capital the amount of $19,752.20 so returned to surplus, but refused to include the other amounts, or any part thereof, credited to the accounts of the officers and employees, and the contingent fund. The petitioner contends that the aggregate net amount of $106,172.17 excluded by the respondent should be included in its invested capital for 1917. During the fiscal year 1917, the petitioner paid against said credits the amount of $54,845.99, thus leaving to the credit of the contingent fund at the beginning of its fiscal year 1918 a balance of $51,326.18, which amount petitioner contends should be included in its invested capital .for the latter year.

Having reached the conclusion above set forth, that the petitioner incurred the liability on September 14, 1915, to pay the amounts authorized and accrued for its fiscal year 1915, and incurred the liability, on September 14, 1916, to pay the amounts authorized and accrued for its fiscal year 1916, petitioner is not entitled to include in its statutory invested capital for 1917 and 1918, any part of said amount of $106,172.17. Since the petitioner had incurred the liability to pay and had accrued on its books the aggregate net amount of $106,172.17 prior to the 'beginning of its fiscal year 1917, the amount on that date had ceased to be a part of the petitioner’s invested capital. It then became an obligation or liability. It was owing to the officers and in effect was borrowed capital, which may not be included in the computation of its invested capital. A corporation is not entitled to include in invested capital items of salary credited to stockholders but not drawn by them. Consolidated Electric Lamp Co., 1 B. T. A. 616. Such items represent borrowed capital, Kelly-Buckley Co., 1 B. T. A. 1154. Accordingly, the action of the respondent, in respect of the issues of the second group, is approved.

The third group of issues relates to the inclusion in invested capital of amounts expended by the petitioner for (1) plans, drawings, and tracings, and (2) patterns, which were used by it in its business. The petitioner contends that it is entitled to include the depreciated cost of those items in its invested capital, while the respondent contends “ that the petitioner has neither established the cost or the March 1, 1913, value of the plans and drawings in use and therefore is not entitled to include in invested capital the amount of $42,000 as contended for by the petitioner.” And with respect to patterns, the respondent contends that there is no competent evidence of record to warrant the conclusion that the petitioner is entitled to include in invested capital any amount on account of the purchase of patterns.”

The evidence in the record before us discloses that it was necessary for the petitioner to prepare detailed plans, drawings, and tracings of each boiler or other article before its manufacture could be commenced. It was also necessary to make a pattern for each casting before it could be manufactured. These plans, drawings, and tracings, as well as the patterns, were thereafter carefully preserved and the former were kept in fire-proof vaults. In fact, so valuable did the petitioner regard the former that duplicates were kept in separate vaults, so that if one set should be destroyed, the other would be available. After the manufacture of a particular article, the plans, drawings, and tracings were preserved for use in connection with the manufacture of duplicate orders in the future. The plans, drawings, and tracings were in many instances ■ also valuable in preparing the engineering data for the manufacture of similar, although not exactly duplicate, articles. During the years involved, approximately 20 per cent of the petitioner’s gross business consisted of duplicate orders, executed from the old plans, drawings, tracings and patterns. These assets were actually used by the petitioner in carrying on its business from year to year, and had a useful life extending over an average period of 20 years. We think that these facts clearly establish that the expenditures in question were capital rather than expense. Such expenditures resulted in the acquisition by the petitioner of additional assets having a useful life of 20 years, and which were actively and continuously used by it in carrying on its business. In fact, the evidence justifies the conclusion that the petitioner could not successfully have operated its business without these assets.

In Union Pacific R. R. Co. v. United States, 99 U. S. 402, the Supreme Court said at page 420:

Theoretically, the expenses chargeable to earnings include the general expenses of keeping up the organization of the company, and all expenses incurred in operating the works and keeping them in good condition and repair; while expenses .chargeable to capital include those which are incurred in the original construction of the works, and in the subsequent enlargement and improvement thereof.

In considering what constitutes a business expense and what constitutes a capital investment, we said, in First National Bank of St. Louis, 3 B. T. A. 807:

Generally speaking, items to be deductible [as business expenses] must be those ordinary and usual expenditures incurred in the conduct of a going business. * * * On the other hand, amounts expended for assets that are to continue in use in the business over several years are usually to be classified as capital items. * * *

It is shown that the assets here in question had a useful life of 20 years, and were actually used in the petitioner’s business over that period. To constitute invested capital, it remains then only to determine their cost. The amount of salaries or wages paid to regular employees, while engaged exclusively in the creation of a capital asset, may be included in invested capital. Gate City Coffin Co., 3 B. T. A. 226.

Here, however, the petitioner seeks to include in invested capital not only the cost of the patterns and the amount of the salary paid to its employes who were engaged exclusively in the preparation of the plans, drawings, and tracings, but also the amount of $2,400 for each year, or one-half of the fixed salary paid to its president and chief engineer, as representing a proper allocation to the cost of the assets of the compensation paid him, on account of his supervision of the drafting room. It does not appear from the evidence that the duties of the president and chief engineer were generally different from those of a chief corporate executive officer, except that in addition to such duties he also supervised the engineering work or preparation of the plans, drawings, and tracings. No additional compensation was paid to him on account of such supervision.

In Federal Plate Glass Co., 6 B. T. A. 351, we held that certain amounts, in addition to stated salaries, paid to the general manager and plant superintendent of the petitioner corporation for services in supervising the construction of plant buildings, were capital expenditures. In that connection we said:

To secure the services of these men for the purposes here indicated, the petitioner paid each of them the amount of $50,000, which was in addition to remuneration for services connected with the operation of the enterprise. We are of the opinion that these payments were capital expenditures and should be included in the computation of the petitioner’s invested capital for proiits-tax purposes in each of the taxable years.

Cf. Grelck Condensed Buttermilk Co., 7 B. T. A. 79.

In each decision above cited, a definite amount, paid to the corporate officers exclusively for their services in that connection, entered directly into the cost of the capital assets. The evidence in the instant case is vague and uncertain with respect to the amount of time devoted by the president and chief engineer of the petitioner to the supervision of the work of preparing the plans, drawings and tracings. No additional compensation was paid to him for such services, and we are unable to say that any part of the compensation paid to its president and chief engineer may properly be included in the cost to the petitioner of said assets. The petitioner’s contention on this point must, therefore, be denied.

In our findings of fact above, we have set out the amount which the evidence shows was actually expended by the petitioner in each year for patterns, and for the services of employees engaged exclusively in the preparation of the plans, drawings and tracings, which, in our opinion, constitute capital expenditures. The fact that those expenditures were improperly charged to expense, and so reported in the petitioner’s tax returns, does not preclude the correction of the error here. The nature of the expenditure must be determined from the facts. Union Metal Manufacturing Co., 1 B. T. A. 395; Gilliam Manufacturing Co., 1 B. T. A. 967.

In computing the petitioner’s invested capital for the fiscal years ended in 1917 and 1918, and the three-month period ended December 31, 1918, there should be included the depreciated cost of (1) plans, drawings and tracings, and (2) patterns, based on the amounts of the yearly expenditures set out in our findings of fact above, the depreciation to be computed upon the basis of a useful life of 20 years.

Reviewed by the Board.

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

       Depreciated balance at beginning of year.


author: SteRniiagen :

text:
    Becker Brothers, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 16954.
    Promulgated January 14, 1928.

      John McQormielc, Esq., for the petitioner.

      Donald D. Shepard, Esq., for the respondent.
   OPINION.

SteRniiagen :

The only questions presented for decision are (1) whether the sum of $79,751.19 credited on petitioner’s books to its general manager as salary for the year 1920, is a proper deduction as a reasonable allowance for his services, and if not, what is a proper allowance; and (2) whether certain unpaid additional taxes for prior years were property deductible from surplus in computing invested capital.

On the first question the parties, by stipulation, introduced in evidence the report of the case of Becker Brothers v. United States, 7 Fed. (2d) 3. In that case tbe United States sued petitioner for certain excise taxes alleged to have been due under the Corporation Excise Tax Law of August 5, 1909. One of the questions involved was whether petitioner was entitled to deduct in each of the years from 1909 to 1914, inclusive, 85 per cent of its net income as salaries due its general manager under the resolution of its board of directors set forth in the findings of fact. The opinion contains the following, with reference to the proceedings in the District Court:

At the conclusion of the evidence, and upon consent of both sides, two questions were submitted to the jury, who rendered special verdicts with respect thereto. The questions submitted by the court were:
(1) “ Q. Whether the resolution and subsequent conduct of the corporation were the means of distributing both salaries and profits?”
(2) “ Q. What was the reasonable value of such service as Becker rendered to the company from 1909 to 1914, inclusive, and by that I mean, what would the company have to pay for a man of his (Becker’s) general capacity to do what he did in the running of the business?”
The jury answered the first question in the affirmative, holding that the resolution relied upon by defendant was a means of distributing both salary and profits. In answer to the second question the jury found the reasonable value of the services of Becker to the corporation to be as follows: for 1909, $12,000; for 1910, $13,000; for 1911, $14,000; and for 1912, 1913, and 1914, $15,000 for each of said years.

A general verdict was thereupon directed by the court and judgment entered upon such general verdict. This judgment, except as to matters not material in this proceeding, was affirmed by the Circuit Court of Appeals of the Second Circuit. • That decision construed and applied the resolution of petitioner’s board of directors taken in connection with its subsequent course of conduct, and held that the amounts set apart to petitioner’s general manager were distributions of both profits and income. We are of the same opinion.

From the very beginning Jacob H. Becker owned from 94 to 96 per cent of petitioner’s capital stock and he and his wife and children at all times owned outright 245 shares, or 98 per cent thereof. The owner of the other 5 shares testified that he was “ a nominal stockholder.” The real stockholders were, therefore, Jacob Becker, his wife and children. In the 24 years elapsing between the organization of the corporation and the date of the hearing of this proceeding, the stockholders received only the amounts called salaries paid or credited under the resolution of the board of directors adopted in 1902. The corporation never declared or paid a dividend. These facts, with the further fact that 90 per cent of the net earnings were distributed to the stockholders in the guise of salaries, clearly indicate, and we so hold, that the distributions made under the resolution were both distributions of profits and salaries. We have before us no corporate action indicating what the board of directors deemed to be an adequate compensation for the services of the general manager. We must determine from the evidence what is reasonable compensation.

That the amounts set apart under the resolution were not reasonable allowances for the compensation of petitioner’s officers is made evident from the following testimony of its bookkeeper and office manager:

Q. Do you know whether this fund was used as a fund for carrying on the business, do you know?
A. I know we needed that money in the business. We could not have run the business without it.

Although petitioner had before it for its guidance the opinion of the Circuit Court of Appeals, it introduced no evidence indicating “ what the company would have to pay for a man of his (Becker’s) general capacity, to do what he did in the running of the business.” However, it appears from the report of the decision in Becker Brothers v. United States, that the jury found that a reasonable compensation for Becker’s services as general manager was from $12,000 to $15,000 a year during the period from 1902 to 1914. We are of the opinion that the reasonable value of the services of Becker as general manager during the year 1920 was $25,000. This amount should be deducted in the determination of net income. The evidence is not sufficient to support any determination as to reasonable salary for 1921.

With, respect to the petitioner’s contention that its surplus should not be reduced by the amount of unpaid taxes for preceding years, respondent’s action is sustained. Section 1207, Revenue Act of 1926. Russel Wheel & Foundry Co., 3 B. T. A. 1168; Rosenfield Dry Goods Co., Ltd., 4 B. T. A. 373.

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


author: Muedock:

text:
    Louis Hilfer Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 7479, 13509.
    Promulgated January 14, 1928.

      A. E. James, Esq., for the petitioner.
    /. A. Adams, Esq., for the respondent.
   OPINION.

Muedock:

Apparently the claim for special assessment has been abandoned. No evidence was introduced with respect to it and no mention was made of it either in the petitioner’s oral argument or in its brief. So far as this feature of the case is concerned our judgment must be for the respondent.

The petitioner’s remaining claim is that for the three years in question it was entitled to be classified for taxation purposes as a personal service corporation. In section 200 of the Revenue Act of 1918, the following definition appears:

Tlie term “ personal service corporation ” means a corporation whose income is to be ascribed primarily to the activities of tlie principal owners or stockholders who are themselves regularly engaged in the active conduct of the affairs of the corporation and in which capital (whether invested or borrowed) is not a material income-producing factor; but does not include any foreign corporation, nor any corporation 50 per centum or more of whose gross income consists either (1) of gains, profits or income derived from trading as a principal, or (2) of gains, profits, commissions, or other income, derived from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive. * * *

As we have already said in Appeal of Bryant & Stratton Commercial School, Inc., 1 B. T. A. 32

These qualifying words, primarily, regularly and aetimely, and material, preclude any definitive classification. They make necessary the application of a flexible judgment * * * which must be applied to the facts of each case which comes before us. No intensive rule can be laid down, and it is not surprising that the Commissioner’s administration of this section of the statute has been an extremely difficult task. The very statement of a rule, if rigidly adhered to, would defeat the letter and intendment of the Act.

It is quite apparent from the evidence that this petitioner meets several of the requirements of the statute. But as to two of the requirements the evidence is not so clear and the respondent contends, and always has contended (as appears from his deficiency notice and answers), that the income of the petitioner is not to be ascribed primarily to the activity of the principal owners or stockholders, but that employees who were not stockholders contributed substantially to the services rendered by the petitioner, and that capital, invested or borrowed, was a material income-producing factor. It was therefore incumbent upon the petitioner to produce evidence to overcome the presumption against it, to present facts to which we could apply our judgment and from which we could intelligently decide whether or not the respondent was in error in denying personal service classification to this petitioner.

On direct examination of its witnesses the petitioner showed that although profits had been made they had been distributed promptly by way of dividends to the stockholders. Cross-examination by the respondent brought out the fact that these dividends had merely been credited to the accounts of the stockholders and that to a large extent they had been left undrawn and at interest with the corporation. A glance at the balance sheets will show that the petitioner had the use of a considerable amount of capital, invested or borrowed, in addition to that carried in the stockholders’ accounts.

The largest part of the petitioner’s income was derived by way of commissions and brokerage for selling merchandise as an agent. The earning of this kind of income would not ordinarily require the use of much capital. Moreover, the sales of merchandise as a principal made by this petitioner would require but a very small amount of capital. Yet we see that the petitioner was borrowing money from its stockholders and from others and that it was paying interest thereon, and that it had invested capital in excess of $25,000. The witness, Louis Ililfer, attempted to explain the use of this capital by saying that it was only a normal amount for such a large business, that principals were sometimes slow in paying commission, and that in order to pay labor and clerical help and to pay the operating expenses of the business this amount of money was necessary. Of course, the mere fact that this capital was available to the petitioner is not determinative of the question of whether or not capital was a material income-producing factor, but the presence of such a large amount of borrowed and invested capital in the petitioner’s balance sheets demands more of an explanation on the part of the petitioner than has been given in this case.

By this same witness, Louis Hilfer, the petitioner tried to show that its income in the taxable years is to be ascribed primarily to the activities of the principal owners or stockholders, and that there were no other elements materially contributing to the income of the petitioner, and particularly that only a small percentage of the petitioner’s income could properly be ascribed to the activities of persons other than the petitioner’s stockholders, in short, that the activities of salesmen did not prevent the stockholders from being primarily responsible for the income of the petitioner. He testified at some length in regard to the manner in which he at St. Louis and Koenig at Chicago, supervised the activities of salesmen under them. He stated that in his opinion the stockholders of the petitioner were responsible for at least 80 per cent of its gross income and that although it might appear that salesmen were responsible for 20 per cent of the gross income, they were, in fact, not responsible for even this percentage. However, there was no showing of any facts on which he based this opinion. From his testimony it was argued that the salesmen were mere messengers and that they were probably misnamed salesmen, that they had no authority or discretion in making sales, and that they only carried out the expressed will of one of the stockholders.

The petitioner has not disclosed the number of salesmen employed by it and the total amounts of salaries and commissions paid to non-stockholders during these years were shown only on cross-examination of the petitioner’s witnesses. From this evidence it appears that during the taxable years the petitioner paid in salaries, commissions, bonuses, and other forms of compensation to nonstockholders over 2.35 times the amount which it paid during the same period as compensation to its stockholders. Some of the nonstockholding employees were no doubt neither managers nor salesmen but we have not been told how many such employees there were or how much they received. We have no reason to assume that their salaries accounted for any particular portion of the total compensation paid employees. From the figures in evidence it would seem that if less than 20 per cent of the gross income of the petitioner is to be ascribed to the activities of the nonstockholders, the petitioner could have more than tripled its income for the period before us by simply dismissing its nonstockholding salesmen and managers. In short, the contention of the petitioner that less than 20 per cent of its income is to be ascribed to the activities of its salesmen is apparently contradicted by figures in evidence relating to salaries and commissions. No attempt was made to explain this apparent contradiction.

In addition, we know that the petitioner had offices at Milwaukee, Wis., and at Indianapolis, Ind., which were in charge of nonstock-holders. The supervision which Louis Hilfer claimed he exercised over the activities of the salesmen at St. Louis could hardly have been exercised, and, so far as we know, was not exercised by any stockholder over the activities of the salesmen at Milwaukee and at Indianapolis. We do not know the amounts of either gross income or net income to be allocated to the different offices. It may well be that a large part of the income of the petitioner must be ascribed to the Milwaukee and Indianapolis offices and to the activities of nonstockholders there employed, and, as we have previously stated, the evidence is contradictory in regard to the importance of salesmen at the St. Louis and Chicago offices. So that under all the facts in this case we are in doubt and we can not say that the income of the petitioner in the taxable years is to be ascribed primarily to the activities of the principal owners or stockholders.

In reaching this conclusion we have not been unmindful of the evidence favorable to the petitioner’s contention. The sale of the product of the Carnation Milk Products Co. on commission was one of the important sources of income to the petitioner, probably the most important. A witness, who was vice president of this company at the time, stated that during the taxable years the petitioner’s offices at Milwaukee and at Indianapolis had not been handling this account in a manner satisfactory to the Carnation Milk Products Co., that as a result the account was taken away from the Milwaukee office later, and some complaint was made to Hilfer in regard to the Indianapolis office, although the account was not taken away. The witness further stated that in his opinion the unsatisfactory handling of the account at these two offices was due to the fact that Hilfer was not able to give his personal attention to the conduct of the business at these offices. It also appears that when Hilfer left the petitioner to take a position in New York, the petitioner’s business showed a loss, where formerly it had shown a profit, and that when Hilfer resigned his position in New York, and returned to the petitioner, it no longer had losses, but was shortly made to pay substantial profits. This testimony has a certain evidential value tending to prove that Plilfer was largely responsible for the petitioner’s income, but with the other testimony favorable to the petitioner’s contention, it fails in connection with all of the evidence to show that petitioner meets with all the requirements of the statute and that it should be classified as a personal service corporation.

Judgment will be entered for the respondent.


author: Lansdon :

text:
    Homer P. Morris, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 6510, 6525.
    Promulgated January 14, 1928.

      O. H. B. BloodwoHh, Jr., Esq., for' the petitioner.

      Thomas M. Wilkins, Esq., for the respondent.
   OPINION."

Lansdon :

The petitioner knows nothing of bookkeeping or of the science of accounting. Such records of his business as were considered by the Commissioner in the determination of the deficiencies and penalties here in question or produced at the hearing of this proceeding are no more than fragmentary and inconclusive memoranda from which it is impossible to determine true taxable income and assess tax liability. In the'absence of books of account containing a reliable record of the petitioner’s business operations, the Commissioner undertook to determine tax liability by taking total bank deposits for each, of the years 1917 and 1918 as a basis for computing gross income for such respective years, which he reduced to net income by deducting some amounts known to be nonincome items and others that were either conceded or proved to be proper deductions.

The evidence discloses that the petitioner deposited in certain banks all receipts from the sale of crops, and that he paid practically all his obligations by checking on such banks. If such deposits represented all the elements of gross income and withdrawals all the expenses incurred in the production of such income, it is obvious that the difference between deposits and withdrawals, less nonincome items, statutory credits, exemptions and deductions, would be the petitioner’s net taxable income. It is equally obvious that such a situation is all but impossible, since there are likely to be many unidentified deposits of other than income items and many withdrawals for other than crop-production expenses. The Commissioner endeavored to identify and deduct all nonincome deposits, and to allow such deductions and exemptions as are authorized by law, and there is no proof that he did not do so except as to matters in which, upon the record, he appears to have been in error.

For the years 1917 and 1918 the Commissioner reduced the petitioner’s payments to share croppers in the respective amounts of $2,500.20 and $4,303.80, and for the year 1917 disallowed any deduction on account of salary of the petitioner for the management of his farm as provided in section 5 (a) of the Revenue Act of 1917, and specifically authorized in article 39 of Regulations 41. The amounts deducted from the petitioner’s payments to croppers, and thereby automatically added to taxable income, are alleged by the Commissioner to represent profits realized by the petitioner from sales of merchandise to his croppers. The evidence does not support this procedure. It was proved at the hearing that the yearly sales of merchandise by the commissary conducted by the petitioner never exceeded $4,000, and that the gross profits from such business were never more than 10 per cent of the turnover. We are satisfied that no net profits were realized from such transactions. In any event, we are unable to see any relation between profits on merchandise sold to the petitioner’s share croppers and the amounts due such croppers from the proceeds of the sale of crops produced by them. We hold, therefore, that the respondent overstated the petitioner’s income for the years 1917 and 1918 in the respective amounts of $2,500.20 and $4,303.80.

It is not disputed that the petitioner was the manager of a business enterprise that used invested capital in its operations in the amount of $48,906.45, as computed by the Commissioner for excess-profits purposes for 1917. In such circumstances the individual owning and operating such an enterprise is entitled, for excess-profits-tax purposes, to deduct from gross income all ordinary and necessary expenses. In article 39 of Regulations 41, the Commissioner thus applies this provision to individual owners and operators:

An individual carrying on a trade or business having an invested capital may in computing net income of the trade or business, for the purposes of the excess profits tax, deduct a reasonable amount designated by him as salary or compensation for services actually rendered by him in conduct of such trade or business.

The evidence is convincing that the petitioner is a highly competent farm operator, with many years of successful experience; that his gross annual income from his business was large; and that he devoted his entire time “ from daylight to darkness ” to the enterprise. A witness thoroughly conversant with farming in Georgia and with the nature, quantity, and quality of the crops produced by the petitioner, testified that he considered Morris’s services as farm manager worth a minimum of $5,000 in the year 1917. The only reason suggested for disallowance of salary as claimed is that the petitioner lived on the farm, and that the values of the products thereof which he consumed were not returned as income. The Commissioner argues that the value of the farm products consumed by the petitioner, in all probability, was an adequate payment for the services rendered. We can not assent to this assumption, which we believe has no support in the statutes or the regulations. Products of a farm consumed by the operator thereof and his family do not appear to come within any of the categories of income enumerated in the taxing statutes and the administrative regulations of the Commissioner. To include the value of such products, even if it could be determined, in the deduction allowable for excess-profits-tax purposes to a farmer as compensation would automatically subject such amounts to normal tax and in effect include in income something which Congress did not intend should be so regarded. If products of a farm consumed thereon are income to the producer, it would seem to follow that the rental value of the farmer’s home, the gratuitous services of his wife and children, and the value of the power derived from draft animals owned by the farmer and used without cost should also be so considered. It is obvious that such items are comparable to the rental value of a private residence, which has never been regarded as income or as a factor in the determination of tax liability.

The deduction claimed here relates only to excess-profits-tax and is authorized by statute and regulations solely for the purpose of equalizing the tax liability of an individual engaged in a business employing invested capital with that of a partnership or corporation in which compensation for managerial services is an ordinary expense. Whatever amount is so deducted remains in income and is subject to tax at normal rates. We have heretofore held that farming conducted for profit is a business enterprise entitled to all deductions allowed other industrial enterprises in the computation of tax liability. Sheridan v. Commissioner, 4 B. T. A. 1299; see also Allen v. Convmonweaith, 188 Mass. 59. We are of the opinion that $5,000 is a reasonable salary for the services rendered in the year 1917, and that such amount is a proper deduction from gross income for such year in the computation of income subject to excess-profits tax.

With respect to the deduction from gross income claimed for the year 1919 on account of losses and bad debts, the respondent contends that as the petitioner’s taxable income for that year was found by comparing bank deposits with bank withdrawals, such amounts were withdrawn from the bank before they could be advanced to croppers or used in cotton deals on the New York market, and that they have already been allowed in the total of bank withdrawals credited against deposits. This reasoning is sound. On this point we approve the determination of the respondent.

Having disposed of all the questions relating to gross income and deductions therefrom upon which the evidence is sufficient to enable us to reach any sound conclusion, it remains only to discuss and decide the allegations of delinquency and fraud made by the respondent. The penalties imposed are set forth in our preliminary statement, and need not be recounted here. The petitioner contends that as more than five years have elapsed since the penalties, if any, were incurred and as he has signed no waivers in respect thereto, the statute of limitations has run, and that, even if properly predicated on facts and law, such penalties can not now be collected. It is a well established rule of law that the statute of limitations does not run against frauds. This, we believe, disposes of the petitioner’s contention as to the 100 per cent and 50 per cent fraud penalties imposed for the years 1917 and 1918, respectively.

The penalty for failure to make an excess-profits-tax return for 1917 was imposed for delinquency. To sustain his contention as to the statute of limitations, the respondent argues that, once having been imposed, such a penalty became a part of the tax, and relies on section 8176 of the Revised Statutes, which expressly provides that “ the amount so added to any tax shall be collected at the same time and in the same manner and as a part of the tax.” These respective contentions of the parties raise two interesting questions of law, but the record of this proceeding requires no decision on either. The waivers are not in the record. The petitioner, having produced no evidence in support of his contention, has failed to sustain the burden of proof necessary to overcome the presumption that the statute does not bar the respondent from collecting the penalty for delinquency. There is also another factor in this matter, not referred to by either party in evidence or argument, which supports the contention of the respondent. The penalty for delinquency was imposed for failure to make a return. Since the petitioner made no excess-profits-tax return for the year 1917, there is no date from which the statute of limitations begins to run, either against the deficiency or the penalty for delinquency. Updike v. United States, 8 Fed. (2d) 913.

The petitioner further argues that section 1004 of the Revenue Act of 1917 does not clothe the Commissioner with authority to impose penalties for either delinquency or fraud. This, of course, is correct, since that provision is a penal section which prescribes penalties only after trial and conviction in court. The Commissioner did not impose the penalties in question under section 1004, but under section 8176 of the Revised Statutes, which was incorporated in section 16 of the Revenue Act of 1916, and reenacted as a part of the Revenue Act of October 3, 19lt. This section provides as follows:

In ease of any failure to make and file a return or list within the time prescribed by law or by the collector, the Commissioner of Internal Revenue shall add to the tax fifty per centum of its amount except that* when a return is voluntarily and without notice from the collector filed after such time aaid it is shown that the failure to file it was due to a reasonable cause and not to willful neglect, no such addition shall be made to the tax. In case a false or fraudulent return or list is willfully made, the Commissioner of Internal Revenue shall add to the tax one hundred per centum of its amount.

This excerpt from the statutes disposes of the petitioner’s contention that the fraud penalties were imposed without authority of law, but leaves undetermined the legal basis for the 50 per cent penalty for failure to file an excess-profits-tax return for 1917. The excess and war-profits-tax Acts of 1917, for the first time, included invested capital as an element for consideration in computing tax liability. This necessarily involved many new administrative problems that could not, in the circumstances, be written into the law. Congress, therefore, conferred rather large powers on the Commissioner in section 213 of the Act, which is as follows:

That the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, shall mate all necessary regulations for carrying out the provisions of this title, and may require any corporation, partnership, or individual, subject to the provisions of this title, to furnish him with such facts, data, and information as in his judgment are necessary to collect the tax imposed by this title.

The petitioner, assisted by a deputy collector, made an income-tax return on February 20,1918. Among other instructions to taxpayers, printed on the form used, was the following:

If your total income from all sources exceeded $6,000 and you received any income from a trade or business with invested capital you should get a copy of the excess profits tax return (Form 1101) and calculate the amount of your tax, if any, as directed therein.

Regulations 41, which contains the provision relating to excess-profits-tax return based on the authority of section 213 of the Revenue Act of 1917, was promulgated not later than February 4, 1918, and therefore was in effect on February 20, when the petitioner made his return on Form 1040. That neither the deputy collector nor the petitioner appears to have known of the requirement for an excess-profits-tax return is not material. The Act authorized the Commissioner to make such a regulation. It had been made, approved by the Secretary, and promulgated, both in Regulations 41 and in income-tax-return Form No. 1040. It was necessary both to safeguard the revenues and to protect taxpayers. It must be presumed that every taxpayer who used Form 1040 was advised of the existence of the regulation and óf the penalty that might be imposed for failure to conform to its requirements. It is not disputed that this petitioner failed to make the required return. In the light of the law, the regulations, and of the facts disclosed by this record, we hold that the penalty for delinquency was legally imposed and may be collected in an amount not greater than 50 per cent of the excess-.profits tax, if any, of the petitioner for the year 1917, which shall be determined by recomputation in conformity with this opinion. Bean v. Hamilton, 289 Fed. 9; Appeal of J. Hudson McKnight, 3 B. T. A. 1060.

Penalties of 100 per cent of the income tax determined by the Commissioner for the year 1917, and of 50 per cent for 1918, are also asserted on account of false and fraudulent returns made by the petitioner. After careful consideration of the entire record, we are of the opinion that the petitioner did not willfully and fraudulently understate his income for such years. The penalties for fraud should not be collected.

[Reviewed by the Board.

Judgment will be entered on IS days’ notice, under Rule SO.

SteeNi-iageN and Murdock dissent.


author: Siepkin :

text:
    Greylock Mills, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 11926.
    Promulgated January 14, 1928.

      Sanford Robinson, Esq., and Truman Henson, Esq., for the petitioner.

      Henry Ranenel, Esq., for the respondent.
   OPINION.

Siepkin :

In this case the question is presented as to whether the statute of limitations has run against the proposed deficiencies for the year 1917, the six-month period ended June 30, 1918, and the fiscal year ended June 30, 1919, and had run against taxes which were collected on October 5,1925, the same being an assessment made-on January 3, 1920, of additional taxes asserted to be due on the return for the jrear 1917, and a portion of the taxes shown to be due by the taxpayer on the return for the fiscal year ended June 30, 1919, assessed November 26, 1919. The deficiency claimed is in the total sum of $111,287.91, as follows:

Calendar year 1917-$42, 476. 36
Period January 1 to June 30, 1918- 14, 568. 67
Fiscal year ended June 30, 1919- 54, 242. 88

The total amount alleged to have been overpaid is $47,090.60.

There is no doubt that the waiver for 1917 taxes, even if valid, expired on April 1, 1924, due to the announcement of the Commissioner to that effect; and the taxes assessed thereafter were barred by the statute of limitations.

In the case of Wirt Franklin, 7 B. T. A. 636, it was held that where the Commissioner gave notice that a consent in writing to the determination, assessment and collection after the time otherwise prescribed by law for such determination, assessment and collection, entered into by the Commissioner and the taxpayer, would expire at a certain time, in the absence of other factors, such as an estoppel against the taxpayer, the Commissioner may not determine, assess, or collect the tax after the date fixed by him for the termination of the consent.

In that case we stated:

Occasionally the courts have construed agreements containing such indefinite terms as terminable at the will of either party, but the more generally accepted construction is either (1) that the contract must be performed within a reasonable time, or (2) that it continues until terminated by either party upon reasonable notice. And where a reasonable time is allowed, the party who is first to perform the conditions of the contract may, by act, deed or otherwise, fix a limitation beyond which he may not extend the time for i>'erformance and upon which the other party to the contract may rely. (See Williston on Contracts, see. 68, ot seq., and cases cited.) We see no reason why the rules laid down by the courts for the purpose of determining the intent of the parties in such cases are not equally applicable to a “consent in writing” such as we have here.

In Henry M. Leland, 8 B. T. A. 974, it was also held that an outstanding waiver concerning the year 1917 expired April 1, 1924.

The instrument set forth in the findings of fact entitled “ Income and Profits Tax Waiver ” which covered the years 1917-1920 is undated but it is shown that it was filed with the respondent by the petitioner on February 6, 1923. However, the petitioner contends that since the Commissioner gave petitioner no notice of its acceptance, it is invalid and of no effect. Petitioner had no notice that the instrument was signed by respondent until October 19, 1925, at which time petitioner saw the instrument at a conference at the Income Tax Unit. At tbis time the petitioner gave notice that it did not consider the instrument valid.

However, the evidence discloses that Sidney Alexander, Head of the Special Audit Division of the Bureau of Internal Revenue, acting under specific authority of the respondent, signed the instruments in behalf of the respondent at some time prior to September, 1923. This instrument so executed, constituted written consent as provided by the statute, but that part of it referring to taxes for the year 1917 we must consider as having expired April 1, 1924.

In the cases of Perkins Land & Lumber Co., 9 B. T. A. 528, and Trustees for Ohio & Big Bandy Coal Co. et. al., 9 B. T. A. 617, it was held that it is not necessary for the Commissioner to sign personally waivers in order to have valid consent in writing.

There then arises the question as to whether that portion concerning the taxes for the years 1918 and 1919 had expired prior to December 18,1925, the date on which the notice of deficiency was mailed to the petitioner. In view of the fact that the Commissioner’s bulletin referred only to waivers concerning taxes for the year 1917, we can not hold that the waiver in question expired as to taxes for 1918 and 1919, simply because it also refers to 1917.

As stated before, in the absence of waivers, the statute of limitations would run on the 1918 taxes on June 15, 1924, and on the 1919 taxes on September 19, 1924. The waiver was filed by petitioner on February 6, 1923, leaving a period of approximately three years between the time of filing the waiver and the time the notice of deficiency was sent to petitioner. However, during that time no notice was given by the petitioner as to a termination of the consent, but on the contrary, a suit was brought by petitioner to compel respondent to accept calendar year returns, which suit was resolved in favor of respondent on March 3, 1924, and as late as December 1, 1925, the petitioner and the respondent were corresponding regarding the taxes in controversy.

In the appeal of the Warner Sugar Refining Co., 4 B. T. A. 5, we said, in holding that a waiver had not expired prior to assessment:

No notice was ever served upon title Commissioner, by the taxpayer, prior to the assessment of the amount here in controversy, as to when it would regard the provisions of the waiver as having' been fully complied with by both parties and become inoperative.

In Appeal of Cunningham Sheep & Land Co., 7 B. T. A. 652, it was held that 20 months was a reasonable time after the filing of a waiver within which the Commissioner might assess taxes.

In the case at bar the petitioner gave notice at a conference on October 19, 1925, that it considered the waiver invalid, but upon the ground that the Commissioner gave no notice of acceptance. Petitioner did not at any time notify the respondent as to the time at which it would consider the waiver to have expired.

We find that the Commissioner acted within a reasonable time after the consent was filed, and must hold that the assessments for the years 1918 and 1919, were not barred by the statute of limitations.

Another question to be considered is whether the Board has jurisdiction to determine whether the statute of limitations had run against the collection on October 5, 1925, of the 1917 taxes.

Section 284 (e) of the Revenue Act of 1926 provides as follows:

(e) I£ the Board finds that there is no deficiency and further finds that the taxpayer has made an overpayment of tax in respect of the taxable year in respect of which the Commissioner determined the deficiency, the Board shall have jurisdiction to determine the amount of such overpayment, and such amount shall, when the decision of the Board has become final, be credited or refunded to the taxpayer as provided in subdivision (a). Such refund or credit shall be made either (1) if claim therefor was filed within the period of limitation provided for in subdivision (b) or (g), or (2) if the petition was filed with the Board within four years after the tax was paid, or in the case of a tax imposed by this Act, within three years after the tax was paid.

While the Board has no jurisdiction of appeals involving over-payments as an original issue, yet when jurisdiction has been assumed in a case involving an asserted deficiency, by section 284 (e) of the Révenue Act of 1926 the Board may determine whether there has been an overpayment. The decision on this point turns upon the question whether the collection of a tax claimed as an overpayment was barred by the statute of limitations at the time of collection.

The collector of internal revenue, on October 5, 1925, collected from the petitioner the sum of $18,791.62, being taxes asserted by the respondent to be due for the calendar year 1917 in addition to those shown on the return. This tax was assessed January 3, 1920. The petitioner filed a claim for refund of this on March 16, 1926, but the claim was rejected on or about September 30, 1926. The return was filed on April 5, 1918, and the period within which this could be collected expired on April 5, 1923, and the waiver in the case expired April 1, 1924. Since collection was not made until October 5, 1925, we must hold that the collection was barred prior to that time by the statute of limitations.

The collector also, on October 5, 1925, collected from the petitioner the sum of $28,298.98, being the balance shown to be due on its return for the fiscal year ended June 30, 1919, in the sum of $21,994.02, together with interest thereon in the sum oí $6,304.96.

In the absence of a waiver the period within which this could be collected would have expired on September 19, 1924, since the return was filed on September 19, 1919, but a waiver was executed which extended the time, and we must hold that this collection was not barred by the statute of limitations.

Reviewed by the Board.

Judgment will be entered that there is no deficiency for the calendar year 1917 am.d that there has been an overpayment of taxes for the calendar year 1917 in the amount of $&8,%98.98. The proceedings, so far as they relate to the period January 1 to Jxme SO, 1918, and the fiscal year ended Ju/ne SO, 1919, are restored to the general calendar for assignment for hearing upon the merits in due course.


author: Milliken :

text:
    O. A. Steiner Tire Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 13356.
    Promulgated January 14, 1928.

      James A. Caldwell, C. P. A., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

Milliken :

Since respondent determined an overassessment for the year 1921, this proceeding is dismissed in so far as that year is involved. Appeal of Cornelius Cotton Mills, 4 B. T. A. 255.

Petitioner took its closing inventory for the year 1920 on the basis of cost. This inventory contained articles which were obsolete or practically unsalable. Believing that petitioner had suffered a ma: terial loss with respect to these articles, those taking the inventory, after consultation and discussion, arrived at an estimate of this loss which was precisely 10 per cent of the total of the whole inventory. Petitioner’s president, who assisted in taking the inventory, was asked how he arrived at this horizontal reduction of 10 per cent. He answered:

We had. on our racks some fabric tires that bad cost us something like $24 or $25 apiece at that time, and we were unable to sell them for anything. We made up an estimate that those tires were worth about $5 apiece,- the 32 by 3%, and we had some 35 by 4% that cost us about $37. We made an estimate of their worth at $15, and put that down on a slip of paper, separate from our inventory, and all through the stock different, things we came to we figured that that was the depreciation, that it had depreciated to a certain extent, and when we got through, it amounted to about twenty-four hundred or twenty-five hundred dollars, Mr. Bay, the young man in charge of the store, and who was also secretary of the corporation, he and I figured that a 10 per cent deduction from this inventory would equalize the thing fairly well.

Petitioner’s bookkeeper, who assisted in taking this inventory, testified that the reduction was taken after a discussion between him and two of petitioner’s officers who assisted in taking the inventory. Asked what this discussion was, he answered:

The discussion was to the value of this old stuff or old stock of merchandise. We arrived at what about the deduction should be, and it was then decided that it would be about ten per cent of the inventory, and that deduction was made.

Petitioner’s president was recalled and testified as follows:

Q. What to your mind, does the inventory of $19,867.52 represent?
A. It represented the true inventory of our stocks.
Q. On what basis?
A. On the basis of cost, less 10 per cent.
Q. What did it represent? Did it represent cost less 10 per cent, or did it represent what was then the market value of the goods on hand? What did it represent?
A. It represented the market value of goods on hand.

From the above excerpts, it appears that it is petitioner’s contention that although the reduction was in fact taken solely on obsolete and practically unsalable goods, this reduction, by a peculiar and exceptional coincidence, was precisely equal to 10 per cent of the total inventory accompanied by the further striking circumstance that although the inventory was taken at cost, a straight reduction of 10 per cent converted it into an inventory taken at cost or market whichever was the lower. We are not impressed with these contentions. Giving to petitioner the most favorable construction that can be placed upon the testimony, it appears that it took an inventory of its salable goods at cost and an inventory of its depreciated goods at market and then combined the two into one. Section 203 of the Revenue Act of 1918 provides as follows:

That whenever iu the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.

In accordance with the authority conferred by statute, the Commissioner promulgated articles 1582, 1583, and 1584 of Regulations 45. We have held that the regulations are in conformity with the statute and its requirements reasonable. Appeal of C. E. Longley & Co., 4 B. T. A. 246. Petitioner has not complied with the same. Petitioner had the right to take its whole inventory at cost or its whole inventory at cost or market whichever was the lower. It followed neither method but attempted to combine the two.

It has not been shown that the inventory claimed by the petitioner more nearly reflected the income than that determined by the Commissioner and in view of the entire record we are of the opinion that the Commissioner’s determination should be approved. Respondent, therefore, did not err in restoring to petitioner’s closing inventory the amount representing the straight deduction of 10 per cent. Cf. Orents Department Stores, Inc., 3 B. T. A. 52, and Adams Motor Co., 4 B. T. A. 589.

Reviewed by the Board.

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