source: Caselaw Access Project

author: Gkeen:

license: Public Domain

text:
    Appeal of SHERIDAN COAL CO.
    Docket No. 4821.
    Decided July 30, 1926.
    Where mining machinery is discarded due to the abandonment of a mine, the taxpayer may deduct from gross income in the year of abandonment the difference between the depreciated cost and the salvage value.

      Edgar M. Morsman, Jr., Esq., for the petitioner.

      John D. Foley, Esq., for the Commissioner.
    Before Maequette, MorRis, Green, and Love.
    The Commissioner determined a deficiency in income and profits taxes for the year 1918 in the sum of $162,537.87. There is in controversy only so much of the deficiency as arises from the dis-allowance of three deductions claimed by the petitioner in its return for the year in question. These deductions are, first, an item of $20,000 claimed as increased or “ extraordinary ” depreciation on what was designated as the Iowa mine, located near Avery, Iowa; second, an item of $100,000 claimed as increased or “ extraordinary ” depreciation on the petitioner’s mine No. 7 at Deitz, Wyo.; and, third, an item of $25,000 claimed as increased or “ extraordinary ” depreciation on a machine known as the Querter Shovel, located at Seldon, Mo.
    FINDINGS OF FACT.
    The petitioner is a domestic corporation engaged principally in mining coal from properties which it owns or leases. In the month of December, 1916, for a consideration of $40,000 paid in cash, it acquired certain property which it set up on its books as follows:
    Iowa Mine No. 1.
    Buildings, equipment, development, etc_$32,805.19
    Land, 40 acres_ 4, 000.00
    Powder_ 595. 35
    Dynamite_ . 97
    Materials_ 598. 49
    Live stock_ 2,000. 00

      The building and equipment accounts for 1917 and 1918 are as follows:
    1917.
    Iowa Mine 1 — Building and Equipment.
    Dr. Cr.
    1-1-1917 Balance_$32, 877. 80 6-9-1917_ $3. 41
    I-31-1917_ 2, 364. 49 6-30-1917 Depreciation-2, 500. 00
    3-31-1917_ 709. 77 7-31-1917 Depreciation-416. 67
    4-23-1917_ 2, 500. 00 8-31-1917 Depreciation-416. 67
    10-15-1917_ 1, 750. 00 9-30-1917 Depreciation-__ ■ 416.67
    II-30-1917_ 1, 046.24 10-31-1917 Depreciation 416. 67
    91. 40 11-30-1917 Depreciation 416. 67
    161. 80 11-30-1917_ 2.00
    12-22-1917_ 143. 21 12-31-1917 Depreciation 416. 67
    12-22-1917_ 368. 50 Balance_ __ 37,900.97
    12-31-1917_ 697.05
    196.14
    42, 906.40 42, 906.40
    1918.
    Iowa Mine 1 — Buildings and Equipment.
    Dr. Or.
    1-1-1918 Balance_$37, 900. 97 1-31-1918 Depreciation_ $346. 54
    1-31-1918_ 54. 54 Sale_ 315.00
    4-3-191S_ 2,495. 00 2-28-1918 Depreciation_ 346. 54
    4-16-1918_ 50. 00 3-30-1918 Depreciation_ 355. 50
    6-15-1918_ 1, 400. 00 6-30-1918_ ' 65. 00 4-30-1918 Depreciation_ 355. 92 5-31-1918 Depreciation_ 355. 92
    10-31-1918_ 173.00 6-30-1918 Depreciation_ 367. 59
    7-31-1918 Depreciation_ 367. 59
    8-31-1918 Depreciation_ 367. 59
    9-30-1918 Depreciation_ 367. 59
    10-19-1918 Insurance_ 1, 980.42
    10-31-1918 Depreciation-. 352. 53
    11-30-1918 Depreciation_ 352. 53
    12-31-1918 Depreciation_ 352. 53
    Depreciation— 20, 000.00
    Balance_ 15, 555. 38
    42,139.17 42,139.17
    The credit of $20,000 appearing under date of December 31, 1918, was actually made in compliance with the instructions of the board of directors following action taken by them at a meeting held January 8, 1919, of which the following is the minute entry.
    It was moved by Mr. Clark and seconded by Mr. Morsman, tbat the mine at Avery be closed down and be abandoned, and that the action of Mr. W. E. Megeath in this respect be approved, also that the officers be directed to continue the junking and sale of all equipment and property at Avery, and further that the auditor be directed to charge up as a loss of 1918 the sum of $20,000.00 on account of investments at Avery as the property will not junk for more than the sum of $25,000.00. Carried unanimously.

      In 1918 it became apparent that “the coal seam had pinched out ” and that the mine could no longer be operated at a profit. In the same year the president of the corporation closed the mine and proceeded to sell all removable property. The sale of this property was completed prior to March 1, 1919, and thereafter the company had no transactions with reference to this mine. The prices received for the machinery and equipment sold were less than was anticipated at the time of the passage of the resolution above quoted, and in order to balance the account it was necessary to enter an additional credit of $6,492.34.
    The petitioner owned and operated several coal mines in the State of Wyoming. Among them was its mine No. 7, located at Deitz. This mine was developed in 1916 to the extent that its production was 155,000 tons. In 1917 it produced 267,647 tons; in 1918, 234,181 tons; in 1919, 57,409 tons; and in 1920, 19,384 tons. The mine was not operated by the petitioner thereafter.
    On April 7,1919, the following resolution was passed:
    Upon motion by Mr. Clark, and seconded by Mr. W. F. Megeatli, tlie following Resolution was adopted by tbe unanimous vote of all Directors present:
    RESOLUTION
    Whereas, a fire occurred in this Company’s mine located at Dietz, Wyoming, and known as Mine Number 7, and which said fire caused a large number of entries to become useless and the same were cemented and closed to prevent said fire from extending throughout the entire mine Number 7, and
    Whereas, said Mine Number 7 has been worked continuously for a number of years and can no longer be operated economically, except as an emergency mine, and
    Whereas, the Company’s mine Number 8, with its new steel tipple and equipment is now completed and capable of producing all of the coal necessary to supply the trade of the Company at Dietz, Wyoming, and
    Whereas, the Company began to close down mine Number 7 in December, 1918, and the same is now closed with all likelihood of never being fully reopened, and
    Whereas, the Company is still carrying on its books of account the machinery, equipment, and development of mine Number 7 at the sum of more than $200,000.00, and the same will not junk for exceeding the sum of $50,000.00, and
    Whereas, depreciation in the sum of only $26,000.00 was charged against said account in 1918 :
    Now, therefore, BE it resolved : That the auditor of this Company, in closing his books for the year 1918, charge off from the 1918 profits of the Company the sum of $100,000.00, and credit the same against the equipment, machinery, and development account of mine Number 7,, said charge to represent the depreciation (extraordinary and ordinary) accrued December 31, 1918, and not heretofore charged against said investment, and
    Be it further resolved: That the auditor depreciate the entire balance of said account during the years 1919-1921, charging off one-third thereof each year.

      The company’s equipment, development and machinery account for its Dietz Mine No. 7, for the year 1918, including therein the charge-off made pursuant to the resolution, is as follows:
    Dr. Cr.
    1-1-1918 Balance_$230,344.39 1-31-1918 Depreciation_ $2,600. 00
    2-28-1918_ 513. 20 1-31-1918 Machinery_ 3, 500. 00
    3-14-1918_ 49. 50 1-31-1918 Machinery_ 7, 628.34
    4-13-1918_ 495. 00 2-28-1918 Depreciation_ 2, 086. 80
    5-15-1918_ 5,352. 00 3-31-1918 Depreciation_ 2, 091. 50
    5-22-1918_ 12.55 4-30-1918 Depreciation_ 2,116.30
    5-31-1918_ 534. 60 5-31-1918 Depreciation_ 2,167.03
    5-31-1918_ 189. 95 6-30-1918 Depreciation_ 2,169.48
    6-24-1918_ 205. 33 7-31-1918 Depreciation_ 2,196. 05
    6-29-1918_ 87. 69 8-31-1918 Depreciation_ 2,220. 93
    6-30-1918_ 690. 95 9-30-1918 Machinery_ 1, 000. 00
    7-24-1918_ 3,188. 82 9-30-1918 Machinery_ 3, 005.13
    8-19-1918_ 619.18 9-30-1918 Depreciation_ 2,193. 56
    8-19-1918_ 85. 00 10-31-1918 Depreciation_ 2,193. 56
    8-27-1918_ 1, 890. 00 11-30-1918 Depreciation_ 2,193. 56
    8-31-1918_ 392. 00 12-31-1918 Depreciation— 2,192.03
    9-10-1918_ 511. 88 12-31-1918 Machinery- 183.17
    9-14-1918_ 208. 00 12-31-1918 Extraordinary
    Depreciation,
    Resolution of
    April 7, 1919_ 100, 000. 00
    Balance- 103,632.60
    245, 370. 04 245,370. 04
    The mine was closed down in 1919 and has been entirely abandoned. As the development of the mine progressed it was found that the roof and bottom conditions were bad. There were numerous “ squeezes ” due to the roof coming down and the bottom rising. These “ squeezes ” occasioned fires in different parts of the mine.
    Because of the unusual conditions which prevailed, it was not possible, in abandoning and closing the mine, to recover the pillar coal or to remove all of the rails used in the various tracks.
    In 1917 an engineer, Querter by name, represented that he had designed an electrically operated machine which, for stripping coal, was superior to the ordinary steam shovel, and in 1918 the company undertook the construction of one of these machines from the designs of and under the supervision of Querter. The machine was completed in 1918 and an unsuccessful attempt was made to operate it. In 1919 changes were made in the machine and another unsuccessful attempt was made to operate it. Thereafter the machine was abandoned. The record does not disclose whether there was any salvage therefrom. The expenditures for construction were as follows: 1917, $1,020.76; 1918, $82,473.57; and 1919, $13,421.73.

      On February 3, 1919, the directors passed a resolution directing the auditor to charge $25,000 against the profits for the year 1918. There is no evidence as to the amount of “ ordinary ” depreciation claimed by the petitioner or allowed by the Commissioner.
   OPINION.

Gkeen:

The three items claimed by the petitioner as deductions for the year 1918 were disallowed by the Commissioner as deductions for that year but were allowed as deductions for the succeeding year. The principal controversy is as to the year for which the deductions should be allowed. '

Where machinery is discarded as the result of a change in business conditions, the taxpayer may deduct in such year the difference between the depreciated cost and the salvage value. Appeal of Dilling Cotton Mills, 2 B. T. A. 127; Appeal of Automatic Transportation Co., 3 B. T. A. 505. The abandonment or permanent closing of a mine, strictly speaking, may not be said to be a change of business conditions, but such a change of condition produces the same economic and pecuniary result so far as the taxpayer is concerned, and the taxpayer is as much entitled to the deduction in the one case as in the other.

In this case the petitioner, having abandoned its Avery Mine in 1918, could reasonably anticipate a substantial loss on the sale of the mine’s equipment. That the amount estimated, i. e., $20,000, was reasonable is established by the subsequent sale of the equipment for more than $6,000 less than its estimated salvage value. We therefore hold this deduction proper.

The evidence as to the $100,000 deduction on the Dietz Mine No. 7 is not sufficient to enable us to pass upon the merits of petitioner’s contention. All that we have before us as evidence of cost is the development and equipment account for the year 1918, as set forth in Exhibit No. 2. The resolution passed by the board of directors indicates that at the time of its passage there was no intention to abandon the mine. There was no computation of the salvage value of the equipment for the purpose of ascertaining the probable loss. The heading or title of the account indicates that it includes the cost of development work. We do not know whether this includes the cost of tunnels, shafts, etc. The loss on these may not be taken until the property is sold or abandoned. The Commissioner’s ruling as to this deduction is correct.

The Querter shovel was not abandoned or junked within the taxable year. A substantial sum of money was expended upon it in the succeeding year in an effort to reconstruct it so that it would be usable. Under such conditions the petitioner is entitled only to a deduction sufficient to cover depreciation due to ordinary wear and tear. The Commissioner’s ruling thereon is correct.

Order of redetermination will be entered after IS days' notice, under Buie 60.


author: Steknhagen Phillips,

text:
    Appeal of THE AMALGAMATED SUGAR CO.
    Docket No. 6439.
    Decided July 30, 1926.
    1. TRe consistent accounting practice of a seller of fungible . goods to accrue' the price fixed by its sales contracts as income in the year of the contract, when the evidence shows that all parties in the trade regard title to the goods as passing at that time and not at the time of later delivery and payment, held correctly to reflect income.
    2. The significance of a form of contract as part of a system of carrying on business may be determined by reference to the usages by which its terms are commonly understood and interpreted by the parties themselves, and evidence of such usages held admissible.
    3. The transfer of title is only one element in considering the consistent and fair reflection of a taxpayer’s income on the accrual basis and is not always controlling. B. B. Todd, Inc., 1 B. T. A. 762.
    4. In considering the significance of a taxpayer’s practice in accounting for goods on hand and of its “ inventory ” and “ inventory account,” the nomenclature employed must give way before a true interpretation of the facts.
    5. The actual construction of a uniform contract by the parties is entitled to greater weight than the dry interpretation of the language itself by a third party.

      E. M. Bagley, Esq., B. Kemp Slaughter, Esq., and Lincoln G. Kelly, O. P. A., for the petitioner.

      A. Colder Machay, Esq., for the Commissioner.
    Before Sterkhagen, LansdoN, and ARundell.
    Proceeding to set aside deficiencies of $210,810.56 for the fiscal year ended February 28, 1918, and $5,453.23 for the fiscal year ended February 28, 1919, upon the ground that the Commissioner has (1) failed to recognize certain payments already made and demands duplicate payment, (2) based depreciation upon inadequate value, (3) determined invested capital by incorrectly subtracting the previous year’s tax from surplus at the beginning of the year. and by incorrectly reducing the earnings available for dividends in an estimated amount of income and profits taxes, and (4) improperly treated the income arising from certain contracts in respect of the sale of sugar as having accrued respectively in the years in question.

      FINDINGS OF FACT.
    For the fiscal year ended February 28, 1918, the petitioner paid income and profits tax of $390,044.56 and for the fiscal year ended February 28, 1919, the petitioner paid income and profits tax of $49,534.61.
    The petitioner is a Utah corporation which manufactures, refines and sells beet sugar at wholesale. It has several factories and warehouses in Utah and Idaho. Throughout its existence it has kept its books and made its returns on the accrual basis. The sugar was of standard and uniform grade, quality and condition and was uniformly sold in bags of 100 pounds each.
    During the fiscal year ended February 28, 1911, the petitioner’s business was conducted in accordance with its general practice and the understanding of those in the trade, as follows:
    Its manufacturing and refining season extends approximately from the beginning of October until the end of December. Most of the sugar is sold through brokers. The selling price is fixed by adding the freight rate to the base price at the seaboard point having the lowest freight rate to the place of delivery. The broker upon receipt of an order prepares the contract and sends copies for execution by the petitioner and the purchaser. All the parties, seller, buyer and broker, have invariably treated these transactions as absolute sales at fixed price as soon as the contract is made. None has ever been repudiated. The buyer frequently resells. In case of sale direct by petitioner without the intervention of a broker, the contract is similar and the understanding is the same. The buyer may and frequently does call for delivery of some or all of the sugar at once, either taking delivery himself or directing delivery to a customer to whom he has resold. He carries the sugar on his books as his own from the time of contract. He usually does not know or care in which particular warehouse the sugar is, or from which one delivery is made. When shipment is made an invoice is sent to the buyer for the amount shipped. When the contract provides that the buyer must take delivery within 30 days, as it usually does, or 42 days, as it does if buyer takes delivery from spot stocks, an invoice is sent to him at the end of such period, as to the quantity of the sugar of which he has not yet demanded delivery or ordered shipment. Buyer must pay the fixed contract price at the end of the contract period whether he has ordered delivery or not, and sometimes petitioner has on hand sugar paid for but undelivered. Ordinarily, the buyer does not pay until he receives an invoice. The price is fixed as to a specified destination and the buyer has no right to change the destination; nor does the contract specify the particular factory or warehouse from which the shipment is to be made. All undelivered sugar is held by petitioner in its several warehouses or in warehouses in Missouri River territory to which some is shipped on consignment. There has always been enough sugar on hand to fulfill the orders.
    The contract in use during the fiscal year ended February 28, 1917, is as follows:
    AMALGAMATED SUGAR 00.
    KANSAS CITY COPY
    Sale No. amai 290 m 2-16-17
    To Chero Cola Co_Columbus, Ga. -Purchaser:
    We confirm sale, as broker for The Amalgamated Sugar Company, Ogden, Utah, 2500 bags Standard Fine Beet Granulated Sugar at 6 93% less two per cent (2%), and also less freight charges to destination. Deduction for freight to be verified by submitting the paid freight bill to seller. To be delivered F. O. B. Cars at factory of the Sugar Company, destined to Ex Whse Memphis Tenn
    Any change in destination above stated by purchaser shall render the contract void, and give the seller the absolute right to stop the shipment while in transit and retake possession or .recover from the purchaser the seller’s price for sugar at the substituted destination.
    Terms : Payable in New York or Chicago exchange.
    Orders for shipment of said sugar to be made by the purchaser in proportionate quantities and intervals during the life of this contract, but all to be ordered shipped soon as possible prom Memphis, Tenn and seller agrees to meet the purchaser’s demands for shipment to the best of its ability, subject to unavoidable delays by the factory or railroad company, and subject also to all delays caused by labor strikes, fire, tornadoes, floods and earthquakes, and any event or contingency beyond the seller’s control.
    In the acceptance of this contract it is agreed that if specifications be not furnished within the stipulated contract period, seller is authorized to complete contract by shipment or delivery of Fine Granulated, at his convenience, soon as possible after expiration of contract date without further notice.
    no guarantee
    Terms, conditions or verbal agreements other than those printed above are unauthorized and will not be taken into consideration in the fulfilling of this contract.
    Please sign and return promptly the attached contract covering your today’s purchase; a signed contract will be forwarded you immediately by The Amalgamated Sugar Company.
    Thanking you for your order as above, beg to remain,
    Very truly yours,
    Meinrath Brokerage Co. _Broker.
    0
    Terms' — Less 2% 7 days apteb
    DATE SHIPMENT

      The words “no guarantee” 'used in the contract are customarily understood in the sugar trade to mean that the price remains fixed and will not be changed by reason of fluctuation in market price.
    The contract in use during the fiscal year ended February 28,1919, is as follows:
    Seller’s Copy prom Broker.
    SUGAR SALES CONTRACT
    THE AMALGAMATED SUGAR COMPANY SALE NO._
    _191_
    Sold to_of_
    Bags Bags Bales 4.25’s '
    _bags ) of 100 pounds at $_ _ basis
    _bales ) Granulated Sugar. Plus $- _i_P. P. Rate
    $- _ delivered
    Rubber stamp
    “ no guarantee ”
    At_ _ _
    Shipment, or (delivery from consignments) to be completed within 30 DAYS PROM DATE.
    Delivery complete on receipt of goods by carriers, E. O. B. factory of Sugar Company, or delivery of warehouse order from consigned stock.
    Any change in destination enroute by buyer shall render this contract voidable, and give the seller absolute right to stop shipment while in transit and retake possession, or recover from the purchaser, the sellers price of sugar at. the substituted destination. Sellers option of routing.
    Deduction for freight paid to be verified by attaching paid freight bill to remittance.
    Terms : Cash, less 2 per cent 7 days after arrival, Payable in New York Exchange.
    conditions.
    In the acceptance of this contract it is agreed that if specifications be not furnished by buyer within the stipulated contract period, seller is authorized to complete contract by shipment or delivery at its convenience as soon as possible after expiration of contract date without further notice. This contract is subject to strikes, fires, transportation and business conditions and extraneous causes which render performance commercially impracticable.
    Terms, conditions or verbal agreements other than these printed above are unauthorized and will not be taken into consideration in the fulfilling of this contract.
    The obligations of seller under this contract shall terminate unless buyer shall have delivered to seller, duly signed, a copy of this contract within 10 days of date.
    During tlie fiscal year ended February 28, 1917, the taxpayer manufactured 924,516 bags of sugar, of which 411,907 were sold and actually delivered during the year. At the close of the year it had sugar sales contracts covering 190,374 bags of sugar undelivered.
    During the year in question sugar sales contracts were carried on the books, in the inventory account, at sales prices. On February 28, 1917, a journal entry was made debiting “ Inventoried cost of sugar sold ” and crediting “ Sugar inventory ” with the sum of $1,132,-714.55, said sum representing “411,907 bags at $2.75,” which was the number of bags sold and actually delivered during the year. Said journal entry contained the explanation: “This leaves 512,609 bags of sugar, consisting of 190,374 bags of sugar sold under contract which will net approximately $6.25 per bag and 322,235 bags of unsold sugar at $6.25, the fair market net at this date.”
    The taxpayer maintained a sales memorandum during the year in question which served also as a perpetual inventory of sugar stocks on hand. Daily entries were made recording all additions made to the stock, and the inventory was reduced by the aggregate of all sales contracts made during the day, whether for immediate or future delivery. Sugar not covered by sales contracts at the close of the year was included in the inventory at cost of manufacture. The sugar covered by sales contracts but not delivered was included in the inventory at sales price.
    Commissions were credited to brokers’ accounts at the same time invoices were rendered to customers against shipments, though at the close of the year commissions were anticipated and entered on the books in respect of unfulfilled contracts. The broker would send no bill for commissions but the parties customarily regarded him as entitled as soon as the contract was signed. The commission is treated and accounted for by petitioner as an expense of the year in which the contract is made and included as a deduction in its tax returns of that year. Allowances to customers for freight charges which they would pay for future shipments under unfulfilled contracts were entered on the books at the close of the year.
    The sugar covered by sales' contracts at February 28, 1917, but undelivered at that date, was invoiced to customers, either by the company or its brokers, during the fiscal year ended February 28, 1918, at the prices stipulated in the contracts, irrespective of any rise or fall in market prices prior to completion of deliveries. When these invoices were made to customers, accounts receivable was charged and sugar sales account was credited with the respective amounts thereof. At the close of the fiscal year 1918 a journal entry was made eliminating the aggregate of these invoices from the sales of the year 1918.
    For the fiscal year ended February 28, 1919, the same policy of accounting within the year for income from unfulfilled sales contracts was followed, though the accounting differed slightly from that employed in the fiscal year ended February 28, 1917. For the fiscal year 1919 the company set up an account known as “Sales Contracts Receivable.” to which it charged the amounts of its sales contracts as and when those contracts were received, a corresponding credit being made to the sales account. The gross sales of the company for the fiscal year 1919, as shown on the books of account, included the aggregate of all sales contracts, whether the sugar had been delivered or not.
    Commissions to brokers and allowances to customers for freight charges were handled on the books during the fiscal year 1919 precisely as they were handled for the fiscal year 1917.
    In respect of sugar covered by contracts, the petitioner assumes the storage and insurance until the expiration of the contract. The insurance policies contained a provision substantially as follows:
    On sugar and sugar in process of manufacture (finished or unfinished'), including sugar bags and packages, empty or otherwise, and Beet Seed, but excluding all other merchandise and supplies of every description, their own and/or on consignment, and/or sold, but not delivered or removed, and/or held for charges or advances, and/or held or owned on joint account with others, and/or for which the Assured has assumed or shall assume liability, all contained in buildings known as Main Buildings and/or “Warehouses” and/or “ Storerooms ” at the Assured’s plants, and/or in and/or on platforms, sheds and/or cars within 800 feet thereof.
    It is hereby understood and agreed that property insured hereunder may be pledged as collateral without prejudice to this insurance and that the same may be warehoused in the names of brokers or agents of The Amalgamated Sugar Company, this insurance to cover the interests of all parties therein.
    This policy covers whilst at the risk of the Assured from and to any place within the United States of America either during period of transit, or whilst on storage, or whilst passing through the premises of Assured at its plants in the States of Utah and Idaho.
    The market price of sugar advanced between the time of contracts made in February, 1917, covering the 190,374 bags of sugar and the time of delivery thereof.
    In its tax return the petitioner treated the contract price of the 190,374 bags of sugar as income accrued in the fiscal year ended February 28, 1917. The Commissioner treated it as income accrued in the fiscal year ended February 28, 1918. He thus reduced petitioner’s 1917 income and sent the petitioner a check for refund of over $50,000. The petitioner has not acquiesced in such adjustment and has not accepted the check.
    The petitioner did not set up on its books in or for the fiscal year ended February 28, 1917, or February 28, 1919, any amount to cover income or profits tax for those respective years or a reserve for such taxes. The 1917 taxes were entered on the books when paid in 1918 and the 1919 taxes when paid in 1920. The Commissioner computed invested capital for 1918 and 1919 by reducing earned surplus at the beginning of the year by the amount of the tax for the previous year and also treated the amount available for dividends as reduced by the tax.
   OPINION.

Steknhagen

: The Commissioner has conceded that the petitioner has paid the amounts of taxes set forth in our findings and that adjustment of the deficiency will be made accordingly. He also confesses error as to the basis of depreciation. To these two issues originally raised by the pleadings we need give no further attention.

The third point of the petitioner is that invested capital has been reduced by taking from the opening surplus the tax for the year just closed and by taking from earnings available for dividends the estimated tax for the current year. Since the hearing the law, as held in Guarantee Construction Co., 2 B. T. A. 1145, has been changed by the enactment of section 1207 of the Revenue Act of 1926, which in effect approves a computation of invested capital made in accordance with the Commissioner’s regulations in so far as it is affected by the tax of the preceding year. The validity of such a computation is therefore no longer open to question. Russel Wheel & Foundry Co., 3 B. T. A. 1168. This section does not, however, affect the question of reducing the earnings available for dividends by the estimated amount of taxes for the current year, which was decided adversely to the Commissioner in L. S. Ayers & Co., 1 B. T. A. 1135, upon the authority of which the petitioner’s claim in this respect is sustained.

The fourth point has been vigorously tried, although we are without a brief for the Commissioner and can not therefore be certain of the grounds and authorities upon which his determination rests. During the fiscal year 1917 the petitioner manufactured and sold sugar and its business was carried on in all respects in its customary manner. There was nothing unique in this year and the facts majr be regarded as those of a normal year of business operations. The evidence upon which the facts are found was all elicited from petitioner’s witnesses — its own employees, buyers of many bags of sugar for many years, and the broker who for thirty years had negotiated the sale of much of the beet sugar of the country. The Government produced no witnesses. Despite vigorous cross examination these witnesses, representing all sides of the sugar trade, presented a clear and consistent description of the business and all agreed upon its salient features.

This taxpayer is one of the principal beet sugar producers in the United States. It has carried on its business for many years and in that time it has not only established a substantial volume of trade but has established uniform customs and practices recognized by all those with whom it has transacted its business. These customs and common understandings are accepted as part of all its transactions. We have admitted all evidence of such customs because it has seemed pertinent and. worthy of consideration. To exclude it from any consideration whatever, and thus to say that it has no probative value, would be entirely unwarranted, for we should be construing contracts and giving regard to general business practices and at the same time leaving out of consideration matters which all the parties thereto regard as inherent in them. It seems clear that, whatever may be said of the weight of such evidence as part of the whole record, and even although it should be found to have but little significance, this would not justify its entire exclusion from the case. The petitioner introduced in evidence a typical contract covering its sales as bearing upon the question when the stipulated price accrued and offered aliunde evidence of customs and usages by the aid of which the contract should be construed. This was objected to as incompetent for the reason that the contract could only be construed according to its literal terms. For example, it was argued by the Government that oral testimony of the commonly accepted meaning of the words “ no guarantee ” appearing in the contract could not be received. The objection, we think, is not well founded, not only because the words are not self-explanatory and of clear and single meaning, but upon a more general ground. Let it be conceded that there may be cases where a single contract, being the subject of litigation, must be construed according to its letter; still we are here dealing not with the disputed rights of the parties to such a specific agreement but with the methods and accounts of a corporation and the extent to which they are affected and illustrated by its uniform contract. The contract itself is only part of its system of doing business, and whether the customs and usages be regarded only as elucidating the contract or as elaborating the description of the system, it seems clearly admissible for the light it may throw upon the general «question of accrual accounting. Since the rule is that even a particular written instrument may be explained and interpreted, as against the Government not a party to it, by extraneous evidence, Converse & Co., 1 B. T. A. 742; J. W. Solof, 1 B. T. A. 776; a fortiori, the significance of a form of contract as part of a system of carrying on business may be determined by reference to the usages by which its terms are commonly understood and interpreted by the parties themselves.

The defense of the Commissioner was founded in great measure upon the argument that the sugar contracted for in February and not delivered until the following year was not sold until delivery— that title did not pass to the buyer until the following year — and hence that the contract price could not be treated as accrued income within the contract year or until title passed. Upon the question of time of passing of title most of the argument has centered, the petitioner’s brief containing elaborate discussion and a wealth of citation. We have considered this and have examined the books at some length, and we are impressed with the realization that however we may decide the question of title generally it must still remain open in respect of the rights of the parties under any particular contract.- Our task goes only so far as to determine whether, under the Eevenue Act of 1916 and the Eevenue Act of 1918, this taxpayer has, upon an alleged accrual basis, properly returned its income for the years in question. The former Act, section 13 (d), is as follows:

A corporation * * * keeping accounts upon any basis other than that of actual receipts and disbursements, unless such other basis does not clearly reflect its income, may, subject to regulations made by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, make its return upon the basis upon which its accounts are kept, in which case the tax shall be computed upon its income as so returned.

Section 212 (b) of the 1918 Act is as follows:

The net income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income. * * *

The matter under these statutes, it will be seen, is not one only of the correct legal construction of each individual contract made by a taxpayer, which in any event could by this Board be only tentative; but one of consistent and fair reflection of the taxpayer’s annual income. As to this, the title is only one element, which may not always be controlling. In B. B. Todd, Inc., 1 B. T. A. 762, the Board held that the sales price was accrued income under a uniform contract expressly providing that title remained in the vendor with a right to repossess for nonpayment. In the instant case all the parties testify to an intention to pass title at the time of execution of the contract, and there is nothing in the instrument itself indicating otherwise. Bather does the form of the instrument use words of immediate sale, such as “sold” or “we confirm sale,” and the sanction of the accrual method given in the Todd case may not be readily withheld here except for reasons other than the time of sale.

But an examination into the question has led us to conclude that in the usual sale by this corporation title passes and the sale is complete when the contract is executed. The passing of title must be determined from the evidence. It is not a question which can be dogmatically answered. The primary factor is the manifest intention of the parties to any given transaction. Hatch v. Oil Co., 100 U. S. 124.

The evidence shows that petitioner’s product is in all respects uniform and is so sold. The rules in respect of sales of fungible goods are applicable. It appears that the goods have in all cases been in existence at the time of contract and that fulfillment of the contract has never failed. Delivery is always made by the seller upon demand of the buyer. The quantity sold is always part of a greater quantity owned by the seller, although the sugar from which the sale is made may be in one or all of several factories or warehouses located in different places in Utah and Idaho, or elsewhere. The location of the particular sugar is not specified for it is a matter of complete indifference to the buyer, who is concerned only with delivery at the prescribed destination.

All of the parties to the greater number of petitioner’s sugar sales for many years — the seller, the buyers, and the leading broker— testify that they have uniformly regarded and treated the sale as complete when the contract is executed. The buyers say “ The sugar is ours ”; the broker calls the contract a positive sale,” and all act consistently with this idea. All account for the sugar on their own books as though ownership were transferred. The seller and broker account for a commission fully earned, and the seller treats such commission as an immediate expense and deducts it on its return for the year of the contract. The buyer inventories the sugar as its own or resells immediately and gives delivery instructions to the seller.

And the petitioner’s accounting is entirely consistent with the concept of immediate sale. Unfortunately for the requirements of this case, the petitioner included the sugar sold and undelivered in a so-called “ inventory account.” The word “ inventory ” in this connection has provoked much of the dispute because it has caused the Government to reason that the inclusion of the sugar in “ inventory account ” connotes a recognition of continuing owership, which is inconsistent with an intention to pass title to another. But the reasoning does not withstand analysis, since it leaves out of consideration the facts and circumstances of petitioner’s accounting system which indicate that its so-called “inventory account” is quite different from a simple inventory. There is a confusion arising from the accounting nomenclature employed and this must always give way before a true interpretation of the facts. In its perpetual inventory, revised daily to advise the management of the current state of affairs, appears the sugar on hand, that part contracted and that available for sale. Its copies of contracts are kept as the original record of sales and its copies of invoices as the original record of sales deliveries and accounts receivable. Thus account is taken currently of the true situation. The financial situation is recorded by including sold but undelivered sugar in the inventory at sales price and the unsold sugar at manufacturing cosh The effect of this is to raise the valuation of closing inventory and thus include the sales profit in gross income. It is not enough under these circumstances to say that the amount of sugar on hand is included in inventory or inventory account. In order to learn the significance of this in determining income, the pricing of the inventory must be considered and the method of accounting for it financially. It is only when translated into their money equivalent that goods on hand may affect the profit and loss statement from which taxable income is determined, and the effect of entering contracted sugar at sales price is the same as if it were taken from inventory and the sale price included in gross sales. This effect is to treat such price as accrued gross income. This was the petitioner’s way of expressing its interpretation of the contracts as passing title in the goods to the buyer and establishing in itself an account receivable.

This uniform recognition by all directly concerned of an intention to transfer title is strong evidence to support such transfer. We do not understand that in any case where the parties themselves intend and agree to pass title without possession the law will refuse to recognize such deliberate agreement, irrespective of whether the goods be specific or fungible. See Williston on Sales (2d ed., 1924), section 146, et seq.; Mackellar v. Pillsbury, 48 Minn. 396; 51 N. W. 222. The actual construction by the parties is always important, Roberts v. Tuttle, 36 Utah, 614; 105 Pac. 916, and is clearly entitled to greater weight than the dry interpretation of the language itself by a third party. As we understand the Government’s contention, it is that, as a matter of law, no title could pass because the location of the goods was not specified, and that even although the goods be fungible there is still not a sufficient identification because there is no specification of the particular greater quantity or mass from which the delivery is to be made. We do not find the law so rigid. In 24 R. C. L. 29, Sales §291, the following statement appears:

But where a certain number of bushels of grain are sold to be taken from a larger mass, it has been held that if the acts and declarations of the parties clearly evince an intention to mate an immediate transfer of title, effect will be given thereto, though there is no actual segregation of the part sold from the larger mass which is and remains in the actual possession of the seller.

The rule in Minnesota is expressed in Mackellar v. Pillsbury, supra, as follows:

Where a certain number of articles are sold out of a greater number of exactly the same kind and quality, with the intention that the title should presently pass, and where the vendee has the absolute right at any time to take the amount or number out of the whole mass or quantity, this is sufficient to pass the title, although the specific articles are not actually fiesignated or separated from the remainder. Under such circumstances, until the separation is made the vendor and vendee are tenants in common of the whole according to their respective interests.

In Gourd v. Healy, 206 N. Y. 423; 99 N. E. 1099, it was held that wine sold in New York by description o'ut of a larger quantity in cellars in Bordeaux, France, could be treated in respect of the passing of title precisely the same as though the wine had been in the vendor’s cellar at the time of the contract, and the buyer was held liable.

Reliance is placed by respondent upon the fact that the vendor insures the goods while in its possession. But title is not controlled by the assumption of the risk of loss or damage. And furthermore, the policy of insurance introduced in evidence covers the interests of all parties in the goods insured, thus taking care of the situation as to such sugar as may be under bailment.

It is also urged that the r'ule as to fungible goods does not apply unless the larger mass is identified as in a specified location, and that since, in the instant case, there may be sugar of the seller in many places from which the contract may be fulfilled title can not pass at least until designation of the mass. No authority for this is cited and no reason is given to support it. In the leading case of Kimberly v. Patchin, 19 N. Y. 330; 75 Am. Dec. 334, the larger mass was in two piles and the rule was nevertheless laid down. There is no doubt that tenancy in common may exist whether the aggregate property of all be in a single mass or in several masses and without regard to the size or proximity of the masses. And, since the American rule of transfer of title is founded in the law of tenancy in common, there would seem no reason why it may not be applied where the masses are separated.

Our attention is directed to Haas Bros., 3 B. T. A. 113, as supporting the Government’s position here. That was an appeal of a buyer under certain specific contracts covering respectively several kinds of groceries and requiring construction under a California statute prescribing identification as a condition of transfer of title. The goods were not identified and in some cases not in existence. In each instance the contract expressly provided that something remained to be done before the buyer was bound and, unlike this case, there was no evidence of intention of all parties that title should pass. The buyer there, like the Government here, sought to prove from the bare words of the contracts themselves that, as a proposition of law and irrespective of actual intent, the title was in him and should be included in his inventory at cost or market whichever was lower. Under the law of California this was not established. That decision is not determinative here. The cases are different and both may stand without conflict.

But concluding as we do that title to the sugar left the seller contemporaneously with the execution of the contract, we repeat for the purpose of emphasis that this is but one consideration when we are called upon to pass upon the taxpayer’s accounting system and say whether it clearly reflected income. The uniform and unquestioned practice of the taxpayer was to regard these contracts as reflecting income. Its customers so regarded them. Its balance sheets treated the price among its assets. This is a consistent basis for accrual and we think it may not be denied on the questionable if not definitely incorrect ground that title remained in the seller.

The petitioner is entitled to judgment on all the issues raised, except that as to the invested capital the tax of the previous year should be treated in accordance with section 1201 of the Revenue Act of 1926.

Order of redeteiynmation will be entered on W days’ notice, under Rule 50. ■

Phillips,

concurring: It is a basic principle of the law of sales that, regardless of the purported intention of the parties, no title can pass unless the subject of the sale is ascertained. In Kimberly v. Patchin, 19 N. Y. 330, it is said:

It is a rule asserted in many legal authorities, but which, may be quite as fitly called a rule of reason and logic as of law, that in order to an executed sale, so as to transfer a title from one party to another, the thing sold must be ascertained.

The Uniform Sales Act, enacted into law in several States and asserted to be a codification of the common law as expressed in the decisions of the majority of the state courts, provides:

Section 17.- — -Where there is a contract to sell unascertained goods no property in the goods is transferred to the buyer unless and until the goods are ascertained, but property in an undivided share of ascertained goods may be transferred as provided in section 6.
Section 6. — * * * In the case of fungible goods, there may be a sale of an undivided share of a specific mass, though the seller purports to sell and the buyer to buy a definite number, weight or measure of the goods in the mass, * * *. (Italics mine.)

In 35 Cyc. 293-295, it is said:

Where the sale is of a part of a specific mass the constituents of which are identical in kind, quality, or value, selection is of course unnecessary, * * *. The general rule and that which seems to be supported by the weight of authority is that even when the constituents of the mass are of the same kind, quality, and value, the property in any portion thereof will not pass by a contract of sale unless the portion has been identified by separation. On the other hand there is a line of well considered cases in which the intention of the parties is regarded as the controlling factor, and the rule is laid down that, although the goods sold have not been separated from the mass, the property therein will pass if such was the intention of the parties, * * *.
The contract of sale may relate to goods of a particular description hut not part of a specific mass, * * *. Under such contracts the property in the goods does not pass to the buyer until there has been appropriation of specific goods to the contract. (Italics mine.)

In Hatch v. Oil Co., 100 U. S. 124, the Supreme Court said:

Sales of goods not specified stand upon a different footing, the general rule being that no property in such goods passes until delivery, because until then the very goods sold are not ascertained.

Granting the most liberal interpretation possible to the so-called “elevator cases,” which hold that title to fungible goods may. pass without separation from the mass of which they are a part, nevertheless, it seems necessary that to constitute a sale there must be some specification or identification of the particular mass of which the goods sold are a part; otherwise, we have merely a sale of goods by description which may be performed by delivery from any source of the goods described.

An examination of the findings of fact leads me to the conclusion that in the instant appeal we have a sale of goods by description, which sale could be performed by delivery from any source, and that the contract, so far as the findings show, did not relate to any specified mass from which the subject of the sale was to be taken. Certainly the contract does not itself refer to any specified goods or mass of such goods. It appears that, at the time of the sale, the seller did have at hand sufficient goods to perform the contract, but so far as the purchasers are concerned there is no showing that they were aware of this fact or contracted with reference thereto or with reference to such goods. Possibly, if the parties had argued that the sugar sold was part of the stock owned by the seller, wherever situated, this might be a sufficient sale of a fro rata portion of all such sugar, but upon this point we are not called upon to express our opinion, since there is no showing that the contract was made by the parties with reference to such ownership. Apparently the purchasers did not know or care whether they were purchasing a part of any sugar then in the possession of the seller or sugar thereafter to be acquired by it.

The legal effects which follow a sale by description are different from those where identified goods are sold. For example, where a description is the means provided for identifying the goods which are the subject of the contract, if the goods are not like the description no title passes though the parties purported to make an executed sale. On the other hand, if the parties purport to make an executed sale and the goods are identified as being those to which the contract related, title would pass even though the goods do not meet the description. In the present instance, what would the situation have been if it had developed that the sugar owned by the seller at the time the contract was made did not meet the description in the contract? I can not believe that the courts would say the the contract had reference to the sugar owned by the taxpayer and that title passed because of that fact. Rather am I inclined to believe that they would hold that the contract referred to sugar by description, that it had no reference to what was in the hands of the seller, and that the seller was bound to deliver, not a portion of his stock on hand, but sugar of the grade required by the contract.

There has been no citation of any authority tending to show that title can pass to goods which are not either specific or part of a specified mass. On the contrary, in each case cited the mass from which the goods were to be taken was specified. In Kimberly v. Patchin, supra, 6,000 bushels of wheat were sold from two piles containing a greater quantity. In that case the court said:

Where the quantity and the general mass from which it is to he taken are specified,, the subject of the contract is thus ascertained, and it becomes a possible result for the title to pass, if the sale is complete in all its other circumstances. (Italics mine.)

But in the instant case the general mass from which it is to be taken is not specified.

In Mackellar v. Pillsbury, 48 Minn. 396; 51 N. W. 222, the court thus states the case:

Cottrell had then on hand in his warehouse between 13,000 and 15,000 Brazilian barrels, and * * * he executed to plaintiff a bill of sale of 12.384 of these barrels. (Italics mine.)

In Gourd v. Healy, 206 N. Y. 423; 99 N. E. 1099, the goods sold were identified as part of a larger quantity in the cellars of Schroeder & Schyler, Bordeaux.

In Pope v. Allis, 115 U. S. 363, the Supreme Court said:

When the subject-matter of a sale is not in existence, or not ascertained at the time of the contract, an undertaking that it shall, when existing or ascertained, possess certain qualities, is not a mere warranty, but a condition, the performance of which is precedent to any obligation upon the vendee under the contract; because the existence of those qualities being part of the description of the thing sold becomes essential to its identity, * * *.

In American Hide & Leather Co. v. Chalkley & Co., 101 Va. 458; 44 S. E. 105, the question was whether title to certain hides had passed so that the plaintiff could maintain an action for the sales price or must sue for damages for breach of the contract. The court said:

The contracts were for the sale of non-specific hides, being agreements merely to sell hides of a particular description. But the specific hides upon which the contracts were to operate had not been agreed upon, and the rule in such case is that the property in the goods does not pass until an appropriation of the specific goods has been made, with the assent of both seller and buyer.

It did not appear in that case whether at the time of the sale the seller had on hand sufficient hides to fill the contract, nor does the court inquire. Whether the hides -were on hand makes no difference, for the contract was with reference to hides of a certain description and not hides of a certain ownership, and so in the instant case.

In the instant case it does not appear where the contracts were consummated or where the goods were located which it is claimed were sold. Under these circumstances, we might be justified in applying to the contracts the most unfavorable construction possible under the laws of any State, but it seems preferable to make use of those principles of the law of sales which have most general application throughout the United States. The general rule, as I conceive it, is laid down in Kimberly v. Patchin, supra, and in Anderson v. Read, 106 N. Y. 333; 13 N. E. 292, where the same court says:

The other fact is that there is in the contract no specification, identification or description of the particular property sold. It was simply 1,000 tons of superphosphates. Where the goods were is in no way designated or intimated. They might have been in Europe, Now York, Georgia, or (as was the truth), not in esse, and still every word of the contract have full significance. How is it possible to say that the title to any particular superphosphate passed to the vendee when there is no description or identification of it to be found in the contract, or any reference to it therein made? Suppose the vendors had had 1,000 tons of the goods in their factory in New York, and that after the signing of the contract, a fire had totally destroyed the factory and its contents, who would have had to sustain the loss of such goods? Is there the least ground for claiming that the vendees must suffer it? Make the same supposition, but place the goods at Atlanta, and the same question arises and the same answer must be given. As is said by Comstock, J., in Kimberly v. Patchin, (19 N. Y. 330, at 333) : “It is not only legally but logically impossible to hold property in such things unless they are ascertained and distinguished from all other things, and this, I apprehend, is the foundation of the rule that, on a sale of chattels, in order to pass the title, the articles must, if not delivered, be designated, so that possession can be taken by the purchaser without any further act on the part of the seller.” This was said in a case where the question arose as to the transfer of title to a quantity of grain, a part of a larger quantity in a warehouse, which was designated and identified, and this court held the title passed on the execution of the contract. But when a quantity of oil was sold out of a stock consisting of different large quantities in different cisterns, and at» various warehouses, and the note of sale did not express the quality or kind of oil sold, or the cistern or warehouse from which it was to be taken, and the purchaser did not even know where the particular oil lay which was to satisfy the contract, the court held the title did not pass (White, Assignee v. Wilks, 5 Taunt. 176), and that case is cited with approval in Kimberly v. Patchin (supra).

In Davis v. Budd, 60 Iowa, 144; 14 N. W. 211, where the contract involved the sale of corn of a certain description, the court said:

The question presented is as to whether the corn which the defendant had on hand to the amount of one thousand six hundred bushels, the amount called for by the contract, was held from May 20 to July 20 at the plaintiff’s risk, so far as damage from heating was concerned. In considering this question we shall assume, as the evidence tends to show, that there was no lack of care on the part of the defendant. But conceding that he bestowed proper care, we have to say that we think that the risk was not on the plaintiff. The contract is executory. No sale of corn took place. The defendant seems to think otherwise. His defense must be regarded as based upon the theory that, though the contract does not call for a specific lot of corn, nor part of a specific mass, the fact that he had a mass of corn on hand of over one thousand six hundred bushels, the amount called for, and of the requisite quality, and offered to make a delivery of one thousand six hundred bushels from the mass, had the effect to transfer to the plaintiff the title to that amount, and to impose upon him all risk of damage to such corn from heating.
Whether, if the contract had called for a part of a specific mass, the title to such part could under the circumstances be deemed to have passed, we need not determine. As tending to show that the title could not be deemed to have passed, see Scudder v. Worster et al., 11 Cush., 573. As tending to show that it might, see Chapman v. Shepard, 39 Conn., 413, and Waldron v. Chase, 37 Maine, 414. Whatever the true rule may be upon this question, it seems to be conceded that title to part of a mass does not pass before severance, unless the contract relates specifically to such mass.
In the case at bar the contract called merely for corn of a specific quality, and could be performed by the delivery of any corn whatever of such quality.

Unless we are to read into the findings of fact something which is not there, and say, because the seller had on hand a sufficient quantity of goods to perform his contract, that it necessarily follows that the contract related to those goods which were on hand, regardless of the knowledge or intention of the buyers, we must hold that there was no sale of any specified goods, or part of any specified mass of s'uch goods, and that no title passed.

On the facts stated it is impossible to distinguish the contracts of sale here involved from those occurring daily where goods are sold for future delivery, the contracts being entered into without regard to the source from which the goods are to come or to the ownership or lack of ownership of such goods by the person who. “ sells.”

I am satisfied, however, that the taxpayer has established an accounting practice which was consistent and reflected its income. Where such is the case, legal theories should not be applied to a point where, in such a case as we have here, it becomes necessary for the taxpayer to determine at his peril when legal title passes under each contract into which he may have entered. The refinements of the law must sometimes give way to practical considerations, and this I conceive to be the intent of section 212 (b) of the Act.

The instant case impresses me as proper for the application of the section, and I therefore concur in the result which has been reached.


author: Littleton

text:
    Appeals of PURITY OATS CO. and PURITY OATS CO. OF DAVENPORT.
    Docket Nos. 4364, 4365.
    Decided July 30, 1926.
    Taxpayers were corporations organized and doing business in tlie State of Iowa during tbe year 1918 and until July 1, 1919, when their assets were sold and they subsequently dissolved during the year 1919. They sustained net losses in 1919. Meld, that the net losses for so much of the year 1919 as expired prior to the dissolution were allowable as deductions from net income for 1918.

      Eliot G. Lovett, Esq., and Dwight P. Green, Esq., for tbe petitioners.

      P. S. Grewe, Esq., for tbe Commissioner.
    Before Jakes, Smith, LittletoN, and Tiutssell.
    These are appeals from determinations of deficiencies in income and profits taxes for tbe year 1918 in amounts which had theretofore been assessed but not paid and which are not disclosed by this record.
    FINDINGS OF FACT.
    The Purity Oats Co., during the taxable year, was an Iowa corporation with its principal office at Keokuk, and the Purity Oats Co. of Davenport was also an Iowa corporation with its principal office at Davenport. On July 1, 1919, the American Hominy Co., a New Jersey corporation, purchased all the assets of the said corporations, subject to their liabilities.
    The American Hominy Co. was adjudged a bankrupt by the United States District Court for the Northern District of Illinois, Eastern Division, on January 4, 1924, and the Chicago Title & Trust Co. was appointed trustee in bankruptcy for the American Hominy Co. and ever since has acted and now is acting as-such trustee.
    On July 1, 1919, said Purity Oats Co. and said Purity Oats Co. of Davenport, respectively, transferred all their assets to the American Hominy Co. and themselves legally dissolved prior to December 31, 1919.
    For the period from January 1, 1919, to June 30,1919, said Purity Oats Co. sustained a net loss of $29,629.19, and said Purity Oats Co. of Davenport sustained a net loss of $96,114.52.

       This decision was prepared daring Mr. James’ term of office.

   opinion. '

Littleton

: The taxpayers claim to be entitled to the deduction of the net losses as above set forth. The Commissioner denied the claim upon the ground that the taxpayers were not in existence for the full year 1919.

The situation presented by these appeals is comparable with that in the Appeal of Patapsco Ballast Co., 1 B. T. A. 1081. The only difference between the two ca^es consists of the fact that these taxpayers had an entire year 1918 and a fractional year 1919, whereas, in the Patapsco case, both years were fractional. We are of the opinion that the decision of the question involved in these appeals is governed by the rule of the Patapsco case, and that these taxpayers are entitled to deduct the net losses sustained in the year 1919 from the net income for the year 1918.

Judgment for the petitioners. Order of re-determination will be entered on 15 days' notice, under Rule 50.


text:
    E. MUELHOEFER & SON, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
    Docket No. 10715.
    Decided July 30, 1926.
    Evidence held, insufficient to show that the Commissioner’s computation of petitioner’s income for 1920 upon the percentage basis was erroneous.

      Maurice T. Weinshenh, Esq., for the petitioner.

      W. H. Lawder, Esq., for the respondent.
    Before Sternhagen, Littleton, and TRussell.
    The petitioner claims that the Commissioner erred in using the percentage method of determining its taxable.income for the calendar year 1920. The Commissioner determined deficiencies of $466.74 for 1920 and $265.30 for 1921. No question is involved concerning the 1921 deficiency.
    FINDINGS OE FACT.
    The petitioner is an Illinois corporation with principal office at Chicago, where it is engaged in the undertaking business. In connection with this work, it owns and operates also an automobile livery business.
    Such records as the petitioner kept of its transactions for 1920 were upon the accrual basis, and that method ivas used by it in computing its income as shown in its return filed for that year. Upon examining this return, the Commissioner made an audit of the petitioner’s books of account. These were poorly kept, and, as a result of the audit, he concluded that he would be unable to determine petitioner’s income for the year 1920, either from the books or from any information which he was able to obtain from the officers of the company. He thereupon proceeded to compute the income from such statistical information as was in his possession by the use of a percentage method as follows:
    Sales reported_$47, 506. 44
    Less: commissions_ 2,151. 09
    Net sales_ 45, 355.35
    Gross income, 61 per cent of net sales_ 27, 661. 76
    Net income, 18 per cent of gross income_ 4, 980. 00
    Net income reported in return_ 3,876. 59
    Net income for year increased_ 1,103.41
   OPINION.

Littleton

: The petitioner contends that, at the time of the Commissioner’s audit, it had, and still has, complete books and records correctly reflecting its income, and that the Commissioner erred in using the percentage method of computing its income for the year 1920.

The Commissioner’s auditor testified that he was unable correctly to determine petitioner’s income from the books made available for his inspection, while an accountant employed by petitioner to make an audit and correct its method of bookkeeping testified that the petitioner’s income for 1920 could be correctly determined from its books.

In regard to the records which petitioner claimed to have, correctly reflecting its income, it was clearly incumbent upon it to disclose their contents to the Board in order that it might be in a position to judge of the correctness or otherwise of the Commissioner’s determination.

In the absence of such records or of any available evidence of the items entering into the computation of the petitioner’s income and disbursements during the year, the Board is manifestly unable to conclude just what the income really was, and is therefore not in a position to say that the determination of the Commissioner was erroneous.

Judgment for the Commissioner.


text:
    THOMAS & HAYDEN MANUFACTURING CO., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
    Docket No. 4804.
    Decided July 30, 1926.

      G. E. Pease, O. P. A., for the petitioner.

      W. E. Lcmder, Esq., for the respondent.
    Refore Steiinhagen, Littleton, and TRttssell.
   Littleton

: This proceeding presents the question of whether the Commissioner correctly denied a deduction of $10,000, as additional compensation of officers, for the calendar year 1919, in which he has determined a deficiency of $2,631.61.

FINDINGS OE FACT.

The petitioner is an Illinois corporation, engaged in the manufacture and sale of neckwear, with principal office at Chicago. It kept its books on the accrual basis.

Prior to and during the year 1919, only two of the officers of the company, J. A. Thomas, president, and T. F. Bohan, secretary, were paid a regular salary, such compensation having been fixed by the directors, prior to 1919, at $4,000 and $2,800, respectively. R. W. Hayden, vice president, who, during the year 1919, was also one of the directors, traveled as a salesman for the company and received compensation in the form of commissions. The company maintained complete books of account, keeping as well a minute book in which were recorded the minutes of matters transacted by the stockholders and directors.

On March 12,1920, the petitioner filed a tentative return of income, in which a deduction of $6,800 was claimed as compensation for its officers. At the same time it obtained an extension of time to May 15, 1920, within which to file a complete return. On May 13, 1920, the complete return was filed, in which a deduction of $6,800 was claimed as officers’ compensation.

The indications early in 1919 were that the profits of the corporation during that year would be in excess of the profits for prior years. In July, 1919, the officers, who were also the directors, informally discussed the business of the corporation, and the matter of increased compensation was then mentioned by the president. It was suggested that, in view of the indications that the profits of the corporation for the year would be greater than in prior years, the corporation would be justified in paying its three officers additional compensation. The amount of such additional compensation which it was thought the corporation would be justified in paying its officers was discussed at the time, but no final action was taken by the directors relative thereto; no resolution was adopted fixing the amounts, nor was any entry made upon the books of account of any additional compensation, within the year 1919. Prior to March 2, 1920, the date on which the directors definitely agreed on the allowance of the additional compensation and adopted a resolution fixing the amount thereof, no liability of the corporation for additional compensation for its officers for 1919 existed. The resolution adopted on March 2,1920, provided as follows:

Motion of R. AV. Hayden that the following salaries be paid to officers for the year 1919; J. A. Thomas, President and Treasurer, $9,050.08; R. AV. Hayden, Vice-President, $2,125; T. P. Bohan, Secretary, $5,725.

On November 9, 1920, the petitioner filed an amended return and claimed therein a deduction for compensation of officers of $16,900.08. The Commissioner declined to allow the increased compensation specified in the above resolution as a deduction from gross income for 1919, upon the ground that the corporation had incurred no liability therefor within the year.

Judgment for the Gommissioner.


author: Smiti-i:

text:
    Appeal of ADAMS MOTOR CO.
    Docket No. 3522.
    Decided July 30, 1926.
    The proof that patent rights paid in to a corporation in 1912 in exchange for $15,000 “ special ” capital stock had no actual cash value in 1919, does not entitle the taxpayer to deduct from gross income of the year 1919 the amount of $15,000 under the circumstances stated herein.

      George E. H. Goodner, O. P. A., for the petitioner.

      Benjamin H. Saunders, Esq., for the Commissioner.
    Before Littleton, Smith, and Teussell.
    This appeal is from the determination of deficiencies in income and profits tax for the years 1918, 1919, and 1920, in the amounts of $7,857.92, $7,148.52, and $4,633.89, respectively, arising out of the action of the Commissioner in (1) revising the inventories as computed by the taxpayer for each of the years in question; (2) disallowing a loss deduction of $15,000 taken by the taxpayer in its return for the year 1919; and (3) reducing the invested capital claimed by the taxpayer for the years 1918 and 1919 by the amounts of $7,500 and $15,000, respectively.
    FINDINGS OF FACT.
    The taxpayer, an Alabama corporation with its principal office at Mobile, was organized in or about the month of November, 1912, under the name of the Adams Machinery & Manufacturing Co., with an authorized common capital stock of $30,000 par value, consisting of 300 shares of the par value of $100 per share, for the purpose of engaging in the manufacture and sale of machinery and 'farm implements. In or about the year 1920, taxpayer’s name was changed to Adams Motor Co.
    On July 13, 1909, and on July 20, 1909, United States Letters Patent Nos. 921,919 and 928,835, respectively, were issued to W. J. Adams, covering his two inventions, known as the Adams Lucky Trucker Manure Distributor and the Adams All-Steel Fertilizer Distributor. Aside from the construction of a few demonstrators, nothing was done by Adams in the way of development and exploitation of these patents until the organization of the taxpayer corporation in or about the month of November, 1912. Immediately upon taxpayer’s organization, the patents in question were acquired by it for a consideration of capital stock of the par value of $15,000; the remaining capital stock being sold for cash at par. The actual cash value of these patents was not a determining factor in reaching a conclusion as to the amount of capital stock to be issued therefor, it being the intent of all the parties at interest that said Adams should be, at all times, the owner of one-half of the issued shares of petitioner’s capital stock, in order that control might be vested in him. Section 10 of taxpayer’s certificate of incorporation provides as follows:
    One Hundred and Fifty shares of the stock subscribed for by W. J. Adams as hereinabove shown are to be paid for- by the said Adams conveying to the company the right to manufacture and sell the articles and territory covered by two certain patents issued to William J. Adams, one numbered 927,919, and dated July 13th, 1909, and the other numbered 92S,S35, and dated July 20th, 1909, and the further right to dispose of the privilege, license or right to use the said patents in any territory covered by the same. The said One Hundred and Fifty shares of stock, or so1 much thereof as may be issued shall always be so kept and identified upon the records of the company that the same may be separated from the other stock of the company no matter into whose hands it may pass. Whenever the said company shall finally abandon the manufacture and sale of the articles covered by the aforesaid patents such abandonment shall be tantamount to the payment to the then holders of the issued portion of said one hundred and fifty shares of stock the par value thereof, provided that the said stock be worth more than par, and shall effect a retirement and cancellation of said shares provided that the said stock be worth not more than par. Should the said stock be worth more than par at the time that the aforesaid abandonment takes place, then the holders thereof shall stand in the same position as though they had drawn upon the said stock a dividend of one hundred per cent, and they shall receive no further dividends thereon until all of the other stock of the company has received a dividend in like amount in money or its equivalent. All certificates which may be issued to evidence all or any portion of said one hundred and fifty shares of stock shall contain something to call attention to the fact that the Company’s records will reveal a special arrangement with respect to said shares. It is the purpose of the undersigned incorporators that the stock to he issued in payment for the aforesaid rights shall always equal the amount of that portion of the capital stock sold for cash, and therefore they agree that one hundred and fifty shares shall be now issued to W. J. Adams, and that one share of stock shall be issued to the said W. J. Adams whenever the capital stock of the Company is increased and one additional share of stock is sold and issued. It is further agreed that for each share of additional stock sold and issued by the company at any time in the future, there shall be issued to the said Adams an additional share of special stock. It is the purpose and agreement of all parties hereto that the stock to be issued to W. J. Adams in payment for said rights shall represent a half interest in this company and as often and whenever the company is authorized to increase its capital stock and a share is sold and issued for cash, then a share must issue to said W. J. Adams, his heirs or assigns. Such shares must be identified as above stated and be subject to the retirement and cancellation provisions herein before written.
    In addition to the capital stock issued to him for his patents, Adams acquired for cash 100 shares, which made him the owner of more than 50 per centum of taxpayer’s authorized and outstanding capital stock.
    In 1910 or 1911, Adams received an offer of $25,000 cash for a controlling interest in his patents, which offer he rejected, as it was his intention to manufacture and sell the patented articles, it being his belief at the time that the revenue to be derived from the manufacture and sale of those articles would be much greater than the cash offer.
    Immediately upon acquiring these patents, the taxpayer commenced the manufacture of the articles covered thereby. Operations were conducted entirely by hand in blacksmith shops, the company being without the necessary funds to erect and equip a plant. Approximately 50 machines were manufactured and sold up to 1916, when operations were discontinued because the petitioner found it impracticable profitably to compete with other manufacturers of similar articles, who were manufacturing their products under more favorable circumstances in modern and well equipped plants. In 1918 the officers and directors again considered the proposition of building a plant for the manufacture of the aforementioned patented articles, but found that, due to the increased costs of material and labor, the necessary building and equipment would cost approximately $300,000, a sum considerably in excess of any available funds phis the taxpayer’s borrowing capacity. In a directors’ meeting held on August 14, 1918, consideration was given to the abandonment of the patents, but Adams prevailed upon the board of directors to reassign the patents to him in order that he might make further effort either to- sell the patents or to have the patented articles manufactured by others on a royalty basis, in consideration for which Adams executed his non-interest bearing promissory note, in the sum of $15,000, in favor of the taxpayer. At a meeting of the stockholders held on the same date the following resolution was adopted:
    At a meeting of the undersigned stockholders of the Adams Machinery and Manufacturing Company, Inc., it was decided that the patents and rights of the Adams Lucky Trucker now owned by the Adams Machinery and Manufacturing Company, Inc., be sold by the said company to Mr. W. J. Adams and Mr. L. G. Adams for the amount of $15,000, same being the purchase price of said patents and rights sold to the Adams Machy & Mfg. Co., Inc., originally by W. J. Adams and L. G. Adams. Furthermore that the Adams Machy & Mfg. Co. Inc. at the time of purchase of said patents and rights paid for same in stock, said stock being a special stock which was divided as follows:
    Stock Certificate #1 issued to W. J. Adams to the amount of 100 shares, and stock certificates #5 issued to W. J. Adams, and transferred to L. G. Adams to the amount of 50 shares; this stock was to bear dividends but not to be considered a par value stock.
    Now the Secretary is ordered to transfer this said special stock to W. J. Adams and L. G. Adams, and now certificates be issued for same, said stock after issuance to be par value stock and worth as much in every way as any other stock of the Adams Machy & Mfg. Co. Inc.
    Subsequently, Adams made every effort to sell the patents or to have the patented articles manufactured upon a royalty basis, but such efforts were unsuccessful. It was understood and agreed among the stockholders and directors that the taxpayer was not to make any demand upon Adams for the payment of the note given by him in consideration of the reassignment of the patents to him by the taxpayer, and that, in the event he was successful in selling the patents or having the patented articles manufactured upon a royalty basis, he wo’uld liquidate the note out of any revenues so derived. Finally, on December 31, 1919, at a special meeting of the stockholders, the following resolution was adopted:
    Resolved, that in consideration of W. J. Adams and L. G. Adams reconveying all their right, title and interest in patents #927,919, dated July 13th, 1909, and #928,823, dated July 20th, 1909, to this Company, that this Company do return to said W. J. Adams and L. G. Adams the notes aggregating $15,000, given by said W. J. Adams and L. G. Adams for said patents. Resolved further that the Officers of this Company are hereby directed to take such steps as may be necessary to effect the object of this resolution.
    Then followed the adoption of a further resolution, which provided as follows:
    That all outstanding Stock shall be of Equal Value; that effective this date, no more “ Special Stock ” exist and all outstanding Stock shall be known as “ Capital Stock,” having equal rights and equal value; that, this amends Article X of the Certificate of Incorporation.
    In pursuance of the foregoing resolutions, Adams reassigned the patents to the taxpayer, which in turn returned to him his note for $15,000. Immediately thereafter the board of directors directed that the patents be charged off on the books as worthless.
    Nothing took place between November, 1912, when these patents were acquired by the taxpayer, and March 1, 1913, which served either to enhance or decrease whatever value they may have had at the time of acquisition.
    In computing its invested -capital for the year 1918, the taxpayer included the aforementioned patents in the computation at a value of $7,500, said amount representing 25 per centum of the par value of the capital stock outstanding at the beginning of the taxable year. For the taxable year 1919, the taxpayer included the note of Adams, given in exchange for the patents, in the computation of invested capital, at its face value, $15,000. In computing its taxable net income for the year 1919, petitioner took a deduction of $15,000, as representing the loss sustained upon the abandonment of the patents. The Commissioner has disallowed any value for the patents or for the note of Adams in his redetermination of the invested- capital for the years 1918 and 1919, respectively; and has disallowed the loss deduction taken by the petitioner in the return for the year 1919 on account of the abandonment of the patents.
    Some time after its organization and the commencement of business, the taxpayer secured an agency contract for the sale of Ford automobiles and certain lines of heavy machinery, which contracts were in full force and effect throughout all of the years in controversy. It was the practice of the taxpayer to accept used cars in part payment for new cars or such used cars as it offered for sale. Used cars so accepted in part payment were entered upon the taxpayer’s books of account at their “trade-in” value and were so carried until the close of the year, at which time they were personally inspected by taxpayer’s president and general manager, who placed a value on each used car, which values, in his opinion, represented their selling values. These values, which were used by the taxpayer for inventory purposes, in computing its taxable net income for each of the years in question, were less than the “ trade-in ” values, or cost, by the following amounts: For 1918 — $6,972.38; for 1919 — $7,170.22; and for 1920 — $6,825.91. The Commissioner has restated the values of used car inventories on the basis of their “ trade-in ” values, or cost, and has adjusted the net income of each of the years in controversy accordingly.
    For each of the years in controversy, the taxpayer first valued its inventories of accessories, tires and tubes, and miscellaneous spare parts at list prices, less trade discounts according to terms of agency contracts. From the sums so obtained it deducted approximately 10 per centum thereof to take care of obsolete and damaged goods included in the inventories, the amounts oí such deductions being as follows: For 1918 — $2,129.76; for 1919 — $1,886.26; and for 1920— $3,687.97. In • each instance the Commissioner has increased the inventories by the amounts of the 10 per cent deductions, and has adjusted the net income of each of the years in controversy accordingly.
    On December 31, 1920, taxpayer had ,on hand certain tractors and implements which had been acquired during the current year at prices which were in excess of their replacement values at that date. For income-tax purposes the taxpayer valued these items at their replacement values, the total of which was $2,422.12 less than their actual cost. The Commissioner has restated the inventory of tractors and implements at cost, and has recomputed the net income for 1920 accordingly.
    The result of the Commissioner’s several adjustments of the inventories outlined above is to increase or decrease the net income of each of the years in controversy as follows:
    1918_$9,102.14 (increase)
    1919_ 45. 66 (decrease)
    1920_ 3, 879. 52 (increase)
   OPINION.

Smiti-i:

(1) The first question presented is whether the patent rights paid in to a -corporation in 1912 in exchange for $15,000 special ” capital stock had a cash value in 1912, which cash value was lost in 1919. The evidence indicates that the value of the patent rights was problematical. The inventor had received an offer for a controlling interest in the patents in 1910 or 1911 of $25.000 and had rejected it. The rights were turned in to the corporation under an agreement whereby 50 per centum of the capital stock was to be issued for the rights and designated as “ special ” capital stock, and 50 per centum of any increase in the number of shares of capital stock outstanding should be received by the inventor as a part of the consideration for those patent rights. Section 10 of the taxpayer’s certificate of incorporation provided in part:

10. * * * The said One Hundred and Fifty shares of stock, or so much thereof as may be issued, shall always be so kept and identified upon the records of the company that the same may be separated from the other stock of the company no matter into whose hands it may pass. Whenever the said company shall finally abandon the manufacture and sale of the articles covered' by the aforesaid patents such abandonment shall be tantamount to the payment to the then holders of the issued portion of said one hundred and fifty shares of stock the par value thereof, provided that the said stock be worth more than par, and shall effect á retirement and cancellation of said shares provided that the said stock be worth not more than par. * * *

It is apparent from the foregoing that the patent rights were pot to be a charge against the entire capital stock of the corporation but only against certain shares of stock that were to be specially issued therefor. The taxpayer found that the manufacture of the patented articles was unprofitable and could not be made profitable, and very shortly after incorporation the manufacture of them was discontinued. The special stock, however, was not immediately returned to the inventor. In 1918, the special stock was replaced by shares of capital stock which had the same status as the shares of stock not specifically issued for the patents. We are of the opinion that the evidence does not warrant a finding that the patent rights had any cash value in 1912, and we are furthermore of the opinion that the taxpayer sustained no loss in 1919 as a result of any discovery that the patent rights were worthless.

(2) The taxpayer took its inventories of new cars, tractors, and implements on the basis of cost or market, whichever was lower. Its inventory of used cars was taken on the basis of market.values which were uniformly less than the “trade-in” values. In the absence of evidence that the inventories of used cars were taken at more than the market the taxpayer’s determinations of such market values are approved. At the hearing of this case a witness for the taxpayer was asked as to how all the inventories of accessories and items were taken. His answer was:

A. Well, accessories; .there are always new accessories coming out, and the ones that we have become obsolete and out of date, and we cannot sell them always when the new things come out, and naturally we have to consider that we have some of these which are shop worn, especially tires and tubes and things of that sort, but especially tires, as there are different sizes, different sizes of wheels; the wheels are being changed every year by the automobile business, different sizes coming out, and this makes quite a difference in the size of the tire, so that naturally the tires that we have on hand become obsolete and deteriorate.
Q. How did you price your inventory on accessories and miscellaneous items?
* * * ❖ # # ❖
A. We take the regular inventory price less' the discount, we would discount the cost, then we would go over the whole inventory, make a summary of all of the different items that we thought were right, and take a depreciation for this amount. In this instance, we arrived at about 10 per cent, which really will not cover it.

We are not convinced from this testimony that the accessories inventory was taken upon the basis of cost or market, whichever is lower. Manifestly, obsolete goods which had no sale value should not have been included in the inventory. A deduction from total inventory based upon an estimate of the decrease in value of the total inventory by reason of the inclusion therein of obsolete and shopworn goods does not necessarily result in bringing the inventory to cost or market, whichever is lower. Upon the record béfore us, we think that the Commissioner was justified in adding to the ac-eessories inventory at the close of the years 1918, 1919, and 1920, $2,129.76, $1,886.26, and $3,687.97, respectively, on account of such depreciation made by the taxpayer. Appeal of Farmers’ Hardware Co., 2 B. T. A. 90; Appeal of Pleasant Valley Ranch Co., 2 B. T. A. 335; Appeal of Alexander Reid & Co., 2 B. T. A. 425; Appeal of J. Van Lindley Orchard Co., 2 B. T. A. 1084.

Order of redetermination will be entered on 15 days’ notice, under Rule 50.