text:
    J. A. Staley, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6435.
    Promulgated December 28, 1927.

      Harry O. Weeks, Esq., for the petitioner.

      George G. Witter, Esq., for the respondent.
   OPINION.

Phillips:

The pleadings present two questions for decision: (1) The extent to which income was received by petitioner upon the organization of a corporation to take over the assets of a partnership, and (2) whether the respondent properly asserts against the petitioner a deficiency determined upon the income of his wife. The facts are stated in the findings and will not be repeated here.

It is the contention of the petitioner at the time of the formation of the corporation, the Fowler Farm Oil Co., he received only GO shares in exchange for his interest in the original project and that the additional 25 shares were not issued in exchange for any interest previously held by him. The parties are in agreement as to the fair market value of the stock at the time of its receipt.

Reduced to simple terms, the question presented is whether the 25 shares which are in dispute were received as the result of a purchase thereof or were received in exchange for an interest previously owned. We are of the opinion that the former is the true situation. The agreement between petitioner, Fowler, and Cline was that each should purchase such interest in the joint venture as he could obtain at a price which he deemed advisable and that later they should pool their purchases. It is clear that each was to act on his own responsibility and not as an agent for the others, even though the others were later to share in the purchase. There was no express trust created nor were the circumstances sufficient to impress an implied trust upon the interests then owned and those purchased later. There was merely an executory contract between these individuals to purchase and sell and until this contract was performed each individual was the owner of the interest purchased by him. When the terms of the contract were carried out the joint venture had terminated and the corporation had come into existence. By reason of the previous agreement, the petitioner acquired 25 shares of stock in the corporation, paying therefor in cash pursuant to the terms of the agreement. This amounts to no more than a purchase of such stock pursuant to the terms of an outstanding agreement. Admittedly, the market value of the stock was much greater than the price paid, but such a purchase, however advantageous, gives rise to no taxable income. We are of the opinion that the gain derived from this transaction is limited to the difference between the fair market value of 60 shares of the stock and $2,500, the amount paid by the petitioner for such stock.

In the deficiency letter, which is addressed to the petitioner, the name of the wife is noted and deficiencies are determined as to both husband and wife. The Commissioner, however, appears to assert both deficiencies against the petitioner. The petitioner alleges that the Commissioner erred in adding to his tax liability that of his wife and asserting the tax of both against him.

Section 210 of the Revenue Act of 1918 imposes the tax upon each individual who receives net income in excess of the credits provided by law and it seems clear that the tax due from the petitioner does not include any deficiency which may be determined against his wife even though because of the laws of Texas any proceeding to recover such tax either from the community estate or from the wife’s separate estate might have to be brought against the husband or the husband and wife, jointly.

In this proceeding we are concerned only with a redetermination of the tax liability of the individual who has filed his petition with the Board, not with the steps which must be taken to collect any tax which may be due from the wife. Nor are we concerned with the question whether because of the laws of Texas a notice to the husband is a sufficient notice to the wife to bind either the community or her separate estate or to serve as the basis of a proceeding by the wife for a redetermination of the deficiency determined against her. The husband is the only party petitioner and it is only his liability which concerns us. The final decision to be entered hereunder should include only the deficiency in tax computed upon the income of the husband as such income was determined by the Commissioner and as modified by our decision upon the first point involved.

Reviewed by the Board.

Decision will be entered on HO days’ notice, wider Bule 50.


source: Caselaw Access Project

author: Siefkin :

license: Public Domain

text:
    Stickley Brothers Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 19925.
    Promulgated December 28, 1927.

      Frank E. Seidman, G. P. A., and Jacob E. Seidmccn, Esq., for the petitioner.

      John F. Greaney, Esq., for the respondent.
   OPINION.

Siefkin :

As to the year 1919, it has been agreed by counsel that petitioner’s return was filed May 14, 1920. Under section 250 (d) of the Revenue Act of 1921, no suit or proceeding for the collection of any such taxes * * * shall be begun, after the expiration of five years after the date when such return was filed.”

Applying that section to these facts, collection of the 1919 deficiency was barred on May 14, 1925, unless the legal situation was changed by the enactment of the Revenue Act of 1924. Section 278 (d) of that Act allows six years after assessment for collection where assessment was made within the statutory time (as it was in this case, assessment having been made December 8, 1923) but section 278 (e) provides:

(e) This section shall not (1) authorize the assessment of a tax or the collection thereof by distraint or by a proceeding in court if at the time of the enactment of this Act such assessment, distraint, or proceeding was barred by the period of limitation then in existence, or (2) affect any assessment made, or distraint or proceeding in court begun, before the enactment of this Act.

We have held that in enacting the latter clause in the above paragraph, Congress provided a further period for collection in cases where the period for collection, had not expired. See Art Metal Works, 9 B. T. A. 491. Under that view, collection of the 1919 deficiency is not barred.

The situation as to the deficiency for 1918 must rest upon the same reasons under which we hold that collection of the 1919 deficiency is not barred. The return was filed June 9, 1919. A jeopardy assessment was made December 8, 1923. Under section 250 (d) of the Revenue Act of 1921, collection was barred on June 9, 1924, except as section 278 (d) of the Revenue Act of 1924 extended the time. Prior to that date, petitioner executed two documents designated “waivers” after the assessment had been made.

Under the view we have taken in the case of Art Metal Works, cited above, it is unnecessary to consider the effect of the “ waivers ” as “ consent to a later determination, assessment and collection ” since, in conformity with our decision in that case we hold that, irrespective of such consent, the period for collection has not yet expired. When the Revenue Act of 1924 was passed, the statutory period for collection of the 1918 deficiency had not expired and we hold that the Commissioner of Internal Revenue, by virtue of section '278 (d) of that Act, was given six years from December 8, 1923, the date of the assessment, within which he might collect the tax.

Reviewed by the Board.

The 'proceeding will be restored to the calendar for hearing upon the merits.

Teussell, Phillips, and Milltken dissent.


author: Tbammelu:

text:
    Burroughs Adding Machine Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9803.
    Promulgated December 28, 1927.

      Thomas G. Long, Esq., for the petitioner.

      JoJm D. Foley, Esq., for the respondent.
   OPINION.

Tbammelu:

The only question presented in this case for decision is whether the Commissioner is in error in refusing to allow the petitioner to place its inventories of factory supplies, small tools stores, and power and maintenance stores on a “ cost or market, whichever is lower,” basis which is the basis used in its valuation of its raw material, goods in process and finished goods. Broadly speaking, the question is, Are the items which have been excluded items which are subject to the usual rules of inventory valuations?

The Commissioner denied the reduction to market on the ground that supplies and items of that character which do not form a component part of the finished product, are pr@perly prepaid expenses and, therefore, should be carried at cost.

The authority for the use of inventories is contained in section 203, Revenue Act of 1918, which follows:

That whenever in the opinion of the Commissioner the nse 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.

Pursuant to the authority vested in him by statute, the Commissioner, with the approval of the Secretary, promulgated regulations governing the use of inventories. Regulations 45, article 1581, provides as follows:

* * * The inventory should include raw materials and supplies on hand that have been acquired for sale, consumption or use in productive processes, together with all finished or partly finished goods * * *.

Article 1581 of Regulations 62 under the Revenue Act of 1921, contains the identical language.

The quoted part of the regulations is not, in our opinion, in conflict with the statute but is a reasonable regulation for the carrying out of the statutory provisions.

The Act provides two tests to which each inventory must conform: (1) It must conform as nearly as may be to the best accounting practice in the trade or business, and (2) it must clearly reflect the income. Article 1582, Regulations 45 and 62.

An examination of accounting authorities shows that while a practical unanimity of opinion exists with respect to the proper treatment of raw materials, goods in process and finished goods, from an inventory standpoint, a wide divergence prevails not only as to the valuation of supplies, but also as to their proper grouping in the balance sheet. The following excerpts will indicate, to some extent, the differences which exist:

R. H. Montgomery, “Auditing Theory and Practice,” vol. 1, p. TT2:

Supplies, Stores, Etc. — In addition to tbe regular stock-in-trade, other supplies are usually on band and should, of course, appear in tbe inventory, unless tbe total value is very small.
These items should be separated from tbe merchandise stock. Such items as fuel, office and factory supplies, and similar materials and stores are in tbe same class of raw materials. Repair parts and construction items are not current assets. Ordinary repair parts and similar items which are to be used and charged to maintenance, say, within a year, are current assets and may be included.
The general rules of inventory valuation apply. Care must be taken that nothing is included except usable items. The auditor should demand the original stock sheets and test their accuracy sufficiently to satisfy himself that the items are genuine ones, and that quantities are not overstated.
It is sometimes found that partly used articles are included under this caption; except under special circumstances, it is not proper to include anything except new and usable materials, which would have to be duplicated at the same or a greater cost if they were not on hand.

W. H. Bell, “Accountants’ Reports,” p. 42:

Some accountants classify supplies which are not actually ingredients of the product — fuel, repair parts, stationery, etc., as Deferred Charges, along with other prepaid expenses, but the author makes a distinction between physical or tangible items and intangible items, including the former in Inventories, under “ Current Assets.”

H. A. Finney, “Principles of Accounting,” vol. 1, ch. 3, p. 11:

Inventories of Supplies. — Should supplies be included among the inventories in the current asset section, or shown among the deferred charges? In the case of factory supplies, there is some ground for the contention that they should be shown as current assets, because they will enter into the cost of finished goods as part of the manufacturing expense, and thus, by the sale of finished goods, will be converted into cash. The same argument does not apply with equal force to salesroom and office supplies.
But even in the case of factory supplies the argument is not conclusive. The deferred charge grouping seems the more logical one, because this is a classification devoted exclusively to prepaid expenses, and hence is the more precise classification. And if factory supplies may be considered as current assets because they will ultimately be absorbed in the cost of manufacture, the same argument could be advanced in favor of including unexpired premiums on policies insuring plant assets, and all other prepaid manufacturing expenses as well.
Another argument sometimes advanced in favor of showing supplies as current assets, is that prepaid expenses at the close of one period will reduce the demands for cash during the next period, and are to that extent the equivalent of cash. But if this argument is a valid reason for including supplies inventories in the current asset group, it is an equally valid argument for including all prepaid expenses in that group, which would mean the complete abandonment of the deferred charge classification except for such items as organization expense and stock and bond discount. (Italics added.)

Walton Course, Advanced Accounting, Lecture 23, p. 6:

Supplies.' — Factory Supplies are those things, such as oil and waste, brooms, and small tools which enter into the cost of manufactured articles by being consumed in the process of manufacture, but do not enter into and become part of the product itself. New supplies are carried at cost. When issued to the factory for use, they are usually charged off as a factory expense. (Italics added.)

E. A. Saliers, “Accountants’ Handbook,” sec. 7, p. 380:

Inventories of Supplies and Repair Materials. — Value of these is cost or market, whichever is lower. If market is lower and a reserve is used, the reserve to be set up is the difference between cost and market. Reserve should or should not be used according as operations are or are not departmentized, because in .former case it is not important that supplies be figured into cost at the reduced value, whereas in the latter case it is, since departments are run on a commercial basis.

R. B. Kester, “Accounting Theory and Practice,” vol. 1, p. 12:

Deferred Charges. — Certain types of expenditure are necessary in every business to secure operating supplies. Fuel must be purchased for heating and power purposes; brooms, oil, waste, and other similar supplies are needed for cleaning and maintaining the business plant; stationery, stamps, wrapping paper, twine, cartons, packing materials, and so forth must always be on hand; insurance policies giving protection against fire are usually purchased for from one to three years and so are seldom completely used up at any given date. All items of this sort, necessary for the operation of the business but not dealt m as stools in trade, are called “ expense assets." The portions of these assets on hand at a given time, the use of which mil be deferred to a later period, are classified as “ deferred charges." (Italics added.)

A good exposition of the reasons underlying the carrying of supplies as a deferred expense is found in “Accounting Theory and Practice,” by R. B. Kester, vol. 1, p. 407, as follows:

Basic Rules for Valuation of Balance Sheet Groups. — We may now consider the principles applicable to the valuation of the various groups on the balance sheet. In the standard form of balance sheet the assets are divided into the three groups: (1) Current, (2) Deferred Charges, and (3) Fixed.
It has been seen that the assets of the current group are used for purposes of settling debts, the payment of expenses, and the purchase of merchandise. In judging the sufficiency of these assets for this purpose, it is absolutely essential to know that the values at which they are carried will be realized when they are converted into cash. From the standpoint of conservative business management an understatement of realizable value may be made, but never an overstatement. Accordingly, the fundamental principle of valuation applicable to this group is that these assets are to be valued at cost or market, whichever is the lower. When so valued, the figures at which they are carried in the balance sheet will usually represent an amount slightly less than the amount which it is expected will be realized from their conversion into cash.
The function of the deferred charges group of assets is to secure an equitable distribution of expense charges between the current and the following period. It is only because certain expenditures have been made during the current period which will benefit the succeeding period, that it is necessary to set up this group of assets. Here the problem of valuation is, therefore, simply the problem of dividing the cost of the expenditures between the current and the next period on the basis of the benefits accruing to each. In some cases the basis of division is one of time, as where an insurance policy is purchased for a definite term. The portion of the policy which has expired during the current period is the portion of its cost to be charged to the current period, the balance being deferred to succeeding periods and therefore carried as an asset. In other cases a physical inventory is necessary to determine the distribution of the cost of expenditures, as when supplies of fuel have been purchased and not entirely consumed during the current period. The basis of the value carried over to the next period is of course a fair portion of the original cost. Market or replacement cost does not have any effect on the valuation of the deferred portion.

Apparently, a part of the confusion among accounting authorities arises on account of the purpose for which the inventory is prepared. Some confusion may also arise on account of the misuse of the word “inventory.” Generally speaking, an inventory is a list or memorandum of articles on hand. While it is entirely proper for the taxpayer to prepare and keep such lists or enumerations of articles or assets on hand, for the purpose of determining taxable income, the statute imposes restrictions. The inventory must conform as nearly as may be to the best accounting practice in the trade or business and must clearly reflect the income. Where an accountant is preparing a balance sheet to show the financial condition of a concern at a given time, certainly it would be conservative business practice to show the supplies at market when there is a wide variation between present day replacement cost or market and cost, and this could not be criticized. But it does not follow that the taxable gain should be determined by the use of such a statement. It may be and frequently is good accounting to set up reserves for future contingent liabilities, but the Revenue Acts do not recognize the same in determining gain or loss. We fail to find a clearly crystallized view as to what is good accounting with respect to supplies.

The purpose of an inventory is to enable a taxpayer to determine his income. Under most circumstances, gain or loss from the sale of articles is determined by taking the difference between cost, or March 1, 1913, value, and the sale price. In recognition of a general accounting practice with respect to a taxpayer’s stock in trade, which he has on hand for sale, taxpayers have been permitted to use the “ cost or market, whichever is lower ” basis in taking the inventory of such articles, and to use the inventories so determined in arriving at taxable income. It enables a taxpayer to deduct from realized income a reduction in value of the goods not yet sold but which are held for sale. In effect it permits the taking of what amounts to a “ paper loss.”

To permit, however, an inventory of supplies which are not bought for sale and which are not consumed or used in production processes, is going further than we feel the statute warrants. It would amount to allowing losses as reflected in the valuation of such supplies when such losses may never be realized by a sale or other disposition of the property. Such a method, in our opinion, does not clearly reflect the income nor does it conform to the best accounting practice.

To provide the full benefit of all expenses incurred in the operation of the business of a corporation, section 234 of the Revenue Act of 1918 was enacted.

The attitude of the Board on the question as to the proper method of treating, for income-tax purposes, supplies on hand to be consumed during succeeding years, is shown in the Appeal of David Baird & Son, Inc., 2 B. T. A. 901, wherein the following statement is made:

The taxpayer kept its books of account upon an accrual basis. It kept a memorandum account of its supplies on hand, and the Commissioner, for the purpose of accurately showing the taxpayer’s net income, has allowed the deduction from gross income of supplies actually consumed during the taxable periods under review instead of the supplies purchased. It appears from the taxpayer’s books of account that for the taxable period ended November 30, 1920, it had invested $3,811.65 of its earnings for the fiscal period in supplies to be consumed during the succeeding year. We thinh that this treatment of the taxpayer's accounts more accurately reflected, its true net income than the system actually employed hy the taxpayer and that such treatment is entirely consistent with an accrual system of accounting. (Italics added.)

It is apparent from an examination of the list of inventory items on which a market value has been denied by the Commissioner, that some of them may properly fall in the class of raw material items or supplies which were used or consumed in the manufacturing or production processes and therefore might properly be inventoried at cost or market, whichever is lower. Since, however, no satisfactory segregation is furnished as between the two classes, the action of the Commissioner will not be disturbed.

Redetermination should be made in accordance with the foregoing.

Reviewed by the Board.

Judgment will be entered on 10 days' notice, under Rule 50.


author: Teussell :

text:
    J. Chr. G. Hupfel Co., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9834.
    Promulgated December 28, 1927.

      L. L. Hamby, Esq., for the petitioner.

      J. Harry Byrne, Esq., for the respondent.
   OPINION.

Teussell :

As to the first issue the proof shows that J. Chr. G. Hupfel had for some years prior to 1887 owned and successfully operated, at a profit, a brewery business under his name in New York City, and had built up an established trade with many customers using his product. This condition had consequently created an intangible asset in the business in the nature of good will which was acquired by petitioner, together with all tangible assets, in that year in exchange for its total capital stock of $500,000. The value of the tangible assets acquired in this purchase was $625,290.86, and the indebtedness assumed was $225,290.86, the net value of tangible assets was $400,000. The average yearly earnings over a period of 11 months prior to the acquisition of the business by petitioner and two years following that acquisition were $44,674.20. The excess of net earnings over 10 per cent on net assets, capitalized at 15 per cent gives $31,161.40, which the Board finds is the value of the good will acquired for stock on that date.

On August 7, 1914, petitioner acquired by purchase the trade and good will, together with tangible assets of the Eppig Brewing Co. The consideration paid was $247,500, of which $86,244.32 was set up on the books of petitioner as representing good will purchased and then charged off as the corporation did not then carry a good will account. This amount of $86,244.32 represents good will acquired for cash.

The Revenue Act of 1918, under which the issue here presented is to be determined, permits the inclusion in invested capital of intangible assets acquired for stock in an aggregate amount not to exceed 25 per cent of the par value of the total stock of the corporation outstanding at the beginning of the taxable year. The value of the good will acquired by petitioner for stock on organization in 1887, which the Board finds to be the sum of $31,161.40, being less than 25 per cent of the capital stock outstanding at the beginning of the taxable years 1919 and 1920, should be included in invested capital for those years.

The purchase by petitioner of the trade and good will of the Eppig Brewing Co. for the sum of $86,244.32 represents a capital expenditure and it is accordingly included in invested capital for 1919 and 1920. American Seating Co., 4 B. T. A. 649; Goodell-Pratt Co., 3 B. T. A. 30; Market Supply Co., 3 B. T. A. 841; Rockford Brick & Tile Co., 4 B. T. A. 313.

In respect to the second issue, the Board has followed the rule laid down by the United States Circuit Court of Appeals in the case of Red Wing Malting Co. v. Willcuts, 15 Fed. (2d) 626, that obsolescence of good will of a business is not the subject of a claim for deduction under section 234 (a) (7) of the Revenue Act of 1918. Manhattan Brewing Co., 6 B. T. A. 952; Olt Brothers Brewing Co., 6 B. T. A. 974; Secor Hotel Co., 7 B. T. A. 158.

On the third issue presented the proof shows beyond question the obsolescence of the brewing plant of petitioner as a result of national prohibition legislation. Petitioner alleges that prior to January 15, 1919, the date of the ratification of the Eighteenth Amendment by the last of the necessary number of States, it had decided to liquidate its business beginning with the date of such ratification, without awaiting the expiration of the 12-month period which would elapse before national prohibition would become effective. Federal regulations prior to 1919 already forbade the manufacture or sale of beer from cereals after July 1, 1919, except for export, and petitioner’s business was the manufacture of beer in bulk for sale in New York City and surrounding territory through various saloons. The evidence supports petitioner’s claim of a final determination in January, 1919, to liquidate its brewing business beginning at once. No further contracts were made for supplies, its system of advancing credits to saloonist customers and financing their operations ceased, and it began, on the other hand, to collect and close up such accounts as could be collected. This action is consistent only with a determination to cease operation, as the marketing of its product was dependent on the maintaining of its fixed trade and this could only be done through the continuance of the credit system by which it controlled the business of its customers. The only thing left for petitioner to do in January, 1919, so far as its brewery plant was concerned, was to either liquidate or to continue as a manufacturer of nonalcoholic cereal beverages and this would require the construction of a bottling plant, which petitioner did not have, at cost of approximately $500,000, with profitable operation most doubtful, as a new market, through other mediums than the saloon, would have to be secured.

Faced with these conditions, petitioner began liquidation on January 15, 1919, of its business by the manufacturing of supplies on hand or under contract into near beer and disposed of this through such of its customers as remained in business. It had no dealcoholiz-ing plant and used a crude process of boiling out the alcohol. After ceasing manufacture in 1920 it continued to dispose of its product on hand, and during 1921 and part of 1922, purchased near beer from another brewer for sale to its old customers and in this way received some return on the trade and custom it had built up in past years. While doing this ft began, in 1921, the remodeling of its brewing plant for general commercial use. Under the proof as to conditions respecting petitioner’s business, the lack of a bottling plant, a trade wholly with the old time saloon and with legislation in effect in January, 1919, which called for national prohibition in 12 months and with the business in process of liquidation, we must conclude that the resulting losses of value of petitioner’s plant as a brewery due to these definite and known conditions were completely established. Up to January, 1919, although faced with legislation which would shortly put an end to its business, it continued in operation and made no deduction for obsolescence in its plant for the year 1918. For the year 1919 it appears to have made a deduction of $117,286.95 for obsolescence of buildings designed and constructed for brewery purposes, this being its determination of the total reduction in value of these assets by obsolescence.

On its brewing equipment and fixtures it made a similar deduction for obsolescence for 1919. The Commissioner allowed in full the obsolescence claimed on equipment for the year 1919 and disallowed the claim for obsolescence of the assets consisting of brewery buildings. We are of the opinion that the evidence proves that the obsolescence of Buildings A, B, C, D, and E began on January 16, 1919, and was completed on January 16, 1920. The fact that these buildings were used for a period subsequent to January 16, 1920, does not alter that fact. Such use has been shown to have been incident to the final liquidation of the business decided and entered upon in January, 1919. In the remodeling and reconstruction of the buildings involved 46.9 per cent of the depreciated cost of Buildings A, B, C, and D and 4.8 per cent of the depreciated cost of Building E represented the portions demolished and no salvage was secured from this operation. The cost of these buildings unextinguished by depreciation taken in past years was $115,191.54 for Buildings A, B, O, and D and $142,225.81 for Building E. Applying the percentages demolished we have $54,024.88 for Buildings A, B, C, and D, and $6,826.84 for Building E, or a total of $60,851.67, allowable as obsolescence for the years 1919 and 1920. Petitioner made its return for the fiscal year from October 1 to September 30, and the total amount of $60,851.67, determined as obsolescence is allowable in the amount of $43,103.27 for the fiscal year 1919 and $17,748.40 for the fiscal year 1920. Manhattan Brewing Co., supra.

The fourth issue is upon the disallowance by the respondent of certain debts charged off by petitioner and deducted from gross income in 1919 and 1920. Prior to the advent of prohibition the value to a brewer of a saloonist as a customer, was measured by his ability to sell beer rather than his personal solvency, and advances were made him by the brewer with no other security than a chattel mortgage on the bar fixtures purchased with the money advanced, and in many cases without even this security. There was before prohibition, a market for bar fixtures or the lease of an established saloon. In case of foreclosure of such a chattel mortgage a substantial amount could be realized from the sale of the security. The indebtedness secured by such chattel mortgage was being automatically paid off from week to week by the debtor through credits on the beer purchased by him from the brewer. In time, if the business continued, the entire indebtedness would be thus paid. When petitioner in January, 1919, began the liquidation of its brewing business, it ceased making further loans to its customers and began to attempt to realize on the debts of such customers on its books. Many of these saloonists had no property. Many had been financially irresponsible at the time the accounts were first opened. With such debtors the only source from which to satisfy a judgment was the bar fixtures covered by the mortgage, and in 1919 these could not be sold for lack of purchasers. No one was then going into the saloon business. Many were going out. Some bar fixtures foreclosed on by petitioner could not be sold at any price and were finally used as fuel.

At the close of the fiscal year ending September 80, 1919, petitioner charged off as bad debts from these saloonists’ accounts the sum of $162,484.91, and deducted these from gross income in making its return for that year. Some of these debts represented the total indebtedness of the particular customer where petitioner could not secure payment of any amount and the debtors were known to him to be insolvent. Some of the amounts charged off in this total represented a portion of the indebtedness of customers, part being held on the books because the debt was not considered entirely uncollectible. In making its return for the fiscal year 1920, petitioner charged off similar items of indebtedness in the total amount of $40,211.93. This latter sum represented in some cases the balance of debts, a portion of which had been charged off in 1919. In other cases the debts charged off represented portions of individual debts determined in 1920 to be partially uncollectible, and others represented debts determined in that year to be wholly uncollectible. The total amounts charged off in both 1919 and 1920 included some items representing the cost of fixtures loaned to customers by the petitioner.

The proof shows very clearly that the evidence of insolvency and financial irresponsibility of the individual debtors and the practically worthless character of the chattels covered by the various mortgages, on which the petitioner based his determination of the uncollectibility of these various debts, amply justified such a conclusion and its correctness is further indicated by the fact that in the six years following the charging off of these debts, less than $2,000 out of the total of more than $200,000 has been collected. In Egan & Hausman Co., 1 B. T. A. 556, the Board said:

In adjusting tlieir accounts and debts business men are called upon to use sound business judgment and prudence and are justified in eliminating from their assets such accounts and debts as are past due and which they are satisfied that they can not realize upon within some reasonably determinable period.

The fact that during the year in which these debts were charged oif and following that year the petitioner continued to do business with these debtors does not negative the correctness of his determination as to the uncollectibility of the debts. Midland, Coal Co., 1 B. T. A. 311. In the present case, however, the proof shows that the business relations of petitioner with these creditors subsequent to the charging off of these debts were not of a character indicating to any degree a belief in their solvency. Sales to them were for cash without discount, credit being extended in some cases for one week in a small amount, and there were no advances of money to them as formerly. The Revenue Act of 1918, section 234(a)(5) permits deduction of “ debts ascertained to be worthless and charged off within the taxable year.” That portion of the total of $162,484.91, charged off in the year 1919, representing debts ascertained in that year to be wholly worthless and charged off in their entirety, is a proper deduction for 1919. This amount is found to be $110,104.97. Applying this same rule to those debts deducted in 1920 and disallowed by the respondent, we find $33,760.17 as properly allowable in that year of the total sum of $40,271.93 then charged off and deducted by the petitioner. This latter amount should be increased by $44,378.88, representing that portion of the total indebtedness charged off in 1919 and not allowable as a deduction in that year because composed of portions of debts not finally determined to be wholly uncollectible until 1920, but for this reason proper for allowance in the latter year. Joseph E. Reed, Estate, 2 B. T. A. 1198; Mason Machine Works, 3 B. T. A. 745; Patrick J. Shouvlin, 3 B. T. A. 499. The totals allowable for 1919 and 1920 of the entire amounts of debts charged off by the petitioner for these two years and disallowed by the respondent are thus determined to be $110,704.97 for 1919 and $78,139.05 for 1920. The balance of the entire amount involved for the years 1919 and 1920, or the sum of $13,912.82, is composed of (a) the amounts of $2,139.49 of the sum for 1919, and $2,513.32 of the sum for 1920, or a total of $4,652.81, representing the value of certain fixtures loaned to various customers by petitioner; (b) the sum of $500.13 in respect of which petitioner admits inability to furnish any information; and (c) the sum of $8,759.88, which represents parts of various debts charged off where there is no evidence to show whether the balance was later charged off or is still maintained on petitioner’s boobs. With respect to the first of these three items it is evident that these charges do not represent debts and accordingly can not he included. Item (b) can not be included as petitioner does not know what, it represents, and item (c) is not allowable as it can not be determined when the debts, a portion of which it represents, were finally determined to be uncol-lectible or whether they were ever so determined.

The deficiencies should be redetermined in accordance with the foregoing findings of fact and opinion.

Reviewed by the Board.

Judgment will be entered upon 15 dags’ notice, pursuant to Rule 50.


author: MaRqtjette:

text:
    Robert L. Scott, Petitioner, v. Commissioner of Internal Revenue, Respondent. Frederick H. Scott, Petitioner, v. Commissioner of Internal Revenue, Respondent. John W. Scott, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 10572, 13106, 10573, 10773, 18867.
    Promulgated December 28, 1927.

      Laird Bell, Esq., for the petitioners.

      Philip M. Clark, Esq., and C. C. Holmes, Esq., for the respondent.
   OPINION.

MaRqtjette:

It is the contention of the petitioners that the contract of March 21, 1914, was in substance either a sale of John E. Scott’s life estate in the 10 per cent interest in Carson, Pirie, Scott & Co. which he reserved to himself by the trust agreement of January, 1911, or a reservation at law to himself and wife of part of the income from such interest, and that in either event the payments made by the petitioners to their mother in 1921 and 1922, pursuant to the contract, were properly deductible from the total income received by them. The respondent, on the other hand, urges that the contract of March, 1914, was what it purported to be on its face, a sale by the father to the sons of the father’s .interest in the partnership in consideration of certain annual payments to be made to the father and mother during their lives, and that the payments involved herein are capital expenditures and therefore not deductible in computing the petitioners’ net income.

We will first discuss the petitioners’ second contention, that the contract of March 21, 1914, was in substance a reservation of income by John E. Scott. We can not, however, agree with that contention. It is true that so long as the sons performed their part of the contract and paid to the father annually the amount of $36,000, he was, in so far as his annual income was concerned, in exactly the same position as he would have been in if he had expressly reserved to himself $36,000 of the annual income of the partnership, that is, his income in each year was $36,000. However, there was in law no reservation. Under the contract the interest in the partnership passed to the sons absolutely and they were free to dispose of it as they might see fit. The amounts to be paid to the father and to the mother were not charges on the partnership interest or the income thereof, and if the petitioners had, immediately after the contract was executed, sold the interest thereby conveyed to them, the purchaser would have taken a clear and unencumbered title and would have been entitled to the free and unrestricted enjoyment of the interest and the income therefrom. Upon the failure of the petitioners to make the annual payments provided by the contract, neither the father nor the mother would have had any interest in or charge upon the property or rights conveyed by the contract of March 21, 1914, but they would have been limited to an action at law against the sons to collect the yearly payments if and when they accrued under the contract. We are of the opinion that there is no merit in this contention of the petitioners.

The petitioners argue that by the trust instrument of January, 1911, the father divested himself of title to the interest in the partnership, reserving to himself for life the income thereof, or in other words, what amounted to a life estate therein; that on March 21,1914, he had nothing to convey to his sons except his life estate in, or the right to the income from, the interest in the partnership, and that by the contract of that date he intended to convey, and in fact did convey only the life estate, although in terms he revoked the trust and purported to make a new conveyance of the entire partnership interest.

It may be admitted for the sake of argument that John E. Scott, by the contract of March, 1914, intended to and did convey to his sons only the right to the income from the 10 per cent interest in the partnership which he had theretofore reserved to himself under the trust agreement of January, 1911, but it does not follow therefrom that the payments to the mother in 1921 and 1922 were a part of the consideration paid for the conveyance of such life estate or the right to receive income. By the trust agreement John L. Scott conveyed his interest in the partnership to Robert L. Scott and his two brothers, reserving to himself the right to the income during his life. Upon the death of John E. Scott the trust was to terminate and the coxpus thereof was to be divided among the three sons. As a part of the consideration for the execution of the trust agreement the sons agreed to pay to their mother, after the termination of the trust, the amount of $20,000 annually during her life. These annual payments, which were not to begin until after the trust had terminated and the sons had received both the corpus and the right to the income therefrom, were obviously not in consideration of the father’s life estate, for that was reserved, not passed, by the trust instrument. It is much more logical and reasonable to hold that they were intended as a consideration for the transfer of the corpus. The sons were, therefore, when the contract of March, 1914, was executed, already obligated to pay to their mother after their father’s death, $20,000 per year as a consideration for the transfer to them of the corpus of the trust property and such payments were not the consideration for the transfer to them of their father’s life estate. There may be merit in the contention that the payments to the father of $36,000 per year under the contract of March, 1914, were made in consideration of his relinquishment of the right to the income from the partnership interest, but they ceased upon the father’s death and are not involved herein. The payments which we are considering are those the sons made to their mother and which, except that they have been somewhat increased in amount, would have been required even if the contract of March, 1914, had never been executed. We attach no particular weight to the fact that by the contract of March, 1914, the payments to the mother were increased in amount, and we are of the opinion that considering the contract as merely a conveyance of the father’s right to the income from the partnership interest, the payments to the mother, which are the only ones involved herein, were not made as a consideration therefor. For the reasons stated we approve the respondent’s action in disallowing them as deductions from petitioners’ income.

Reviewed by the Board.

Judgment will be entered for'the respondent.

Tkusselu dissents.


author: Teammeli. :

text:
    Construction Company of North America, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8134.
    Promulgated December 28, 1927.

      Wm. H. Hv/mphrey, Esq., and Morgan J. Doyle, Esq., for the petitioner.

      A. H. Mwray, Esq., for the respondent.
   OPINION.

Teammeli. :

The determination of the respondent that the notes given in payment for the capital stock should be excluded from invested capital was based upon the ground that under the laws of the State of Delaware notes may not legally be taken in payment of capital stock. At the hearing, however, no contention was made with respect to this basis for the disallowance of the notes in invested capital but it was contended that it was not proven by the evidence that the notes given for the capital stock had any value.

Section 14 of Article I of the General Corporation Laws of Delaware provides:

Subscriptions to or purchase of the capital stock of any corporation organized or to be organized under any law of this state may be paid for wholly or partly by cash, labor done, by personal property, or by real property or leases thereof, and the stock to be issued shall be declared and taken to be fully paid stock and not liable to any further call, nor shall the holder thereof be liable for any further payments under the provisions of this Chapter. And in the absence of actual fraud in the transaction, the judgment of the Directors as to the value of such labor, property, real estate or leases shall be conclusive.

We find no specific inhibition in the statutes of Delaware that promissory notes may not be taken in payment for capital stock.

This is a much stronger case than a situation where the statutes of the States specifically prohibit notes from being paid in for capital stock. Even in that case, in the absence of a provision of the statute or a clear implication therefrom that the notes were void, we have held that they should be included in invested capital. Max Kaufman & Co. v. Bowers, 11 Fed. (2d) 662; Hewitt Rubber Co., 1 B. T. A. 424 (N. Y.); American Steel Co., 1 B. T. A. 839 (Pa.); Cross Mountain Coal Co., 2 B. T. A. 587 (Tenn.); Feeders Supply Co., 8 B. T. A. 839 (Mo.).

It appears from the testimony that the notes were actually given in consideration for the issuance of the capital stock and this fact is admitted in the answer of the respondent.

Section 326 of the Revenue Act of 1921 provides that the term “ invested capital ” means (1) actual cash bona fide paid in for stock or shares; (2) actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment; (3) paid-in or earned surplus and undivided profits; (4) intangible property bona fide paid in for stock or shares.

Section 325(a) provides that the term “intangible property” means, among other things, notes and other evidences of indebtedness.

In view of the statute, only the actual cash value of the notes at the time paid in shall be included in invested capital. It was alleged in the petition that the makers of the notes were able to pay on demand, which allegation was denied.

There was no evidence of any character as to what the actual cash value of the notes paid in for stock was. In the absence of some evidence on the question we can not assume that the notes were worth their face value. There is no evidence that the makers of the notes were solvent and able to pay them. We, therefore, approve the determination of the respondent.

Reviewed by the Board.

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


author: Smith :

text:
    Appeals of Franklin Q. Brown and Otto J. Thomen.
    Docket Nos. 3110, 3364.
    Promulgated December 28, 1927.

      Eckvard E. Hanlon, Esq., for the petitioners.

      Blount Balls, Esq., for the Commissioner.
   OPINION.

Smith :

The issues in these appeals are (1) whether the cancellation by Eedmond & Co. of indebtedness of the Pine Street Corporation and of the Securities Corporation, and the issue to Eedmond & Co. by these corporations of additional capital stock were transactions from which gain or loss was realized and, if so, the amount of such gain or loss to Eedmond & Co.; (2) whether the stock of the corporations mentioned was properly included in its inventory by Eedmond & Co.; and (3) whether Eedmond & Co. should be allowed to deduct as rent, the amount of the deficit shown on the books of the Pine Street Corporation for the year 1918.

We are of the opinion under the circumstances and on the facts in these cases that the issues of stock by the corporations mentioned in consideration for the cancellation by Eedmond & Co. of indebtedness against them were not such transactions as resulted in gain or loss. The Eevenue Act of 1918 permits an individual, and likewise a partnership, under section 214(a), to deduct from gross income in computing net income:

(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in trade or business;
(5) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business; but in the case of a nonresident alien individual only as to such transactions within the United States;
(6) Losses sustained during the taxable year of property not connected with the trade or business (but in the case of a nonresident alien individual only property within the United States) if arising from fires, storms, shipwreck, or other casualty, or from theft, and if not compensated for by insurance or otherwise.

It further provides under section 202(b) as follows:

When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any; * * *

The transactions by Eedmond & Co. with the two corporations of which it owned all the stock of each were not arm’s-length transactions. No actual loss was sustained by the partnership, regardless of how the transactions might be treated on the partnership books of account. From the standpoint of the corporations, we could not hold that the release of the corporations from the indebtedness resulted in any income to the corporations. This clearly follows from the decision of the Circuit Court of Appeals, Second Circuit, in United States v. Oregon-Washington R. & Nav. Co., 250 Fed. 211, in which it wc.s held:

Under Corporation Excise Tax Act Aug. 5, 1909, § 38, tlie term “ income ” must be accepted as those more or less periodic earnings, as distinguished from permanent sources of wealth; hence, where the solo stockholder of a corporation which furnished the capital released a debt in favor of the corporation, such sum should be treated as capital rather than income, though such a release cannot be treated as a mere matter of bookkeeping, but as adding to the corporate assets.

See also Kerbaugh-Empire Co. v. Bowers, 271 U. S. 170; Appeal of Independent Brewing Co., 4 B. T. A. 870. Although the transaction before us is the converse of that considered in the above cited cases, we think the same ruling must follow, namely, that no loss was sustained by Redmond & Co., but that the transactions simply amounted to contributions of capital to corporations by the sole stockholder.

Exception is taken by the petitioners to the action of the Commissioner in excluding from inventory the stock of the Pine Street Corporation and of the Securities Corporation. The method of determining income by use of inventories is controlled by section 203 of the Revenue Act of 1918, which reads as follows:

That whenever in 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.

Article 1585 of Regulations 45, as amended by Treasury Decision 3296, promulgated by the Commissioner under the authority given in section 203, quoted above, reads as follows:

Inventories by dealers in securities. — A dealer in securities, who in his books of account regularly inventories unsold securities on hand, either (a) at cost or (6) at cost or market, whichever is lower, or (c) at market value, may make his return upon the basis upon which his accounts are kept; provided that a description of the method employed shall be included in or attached to the return, that all the securities must be inventoried by the same method, and that such method must be adhered to in subsequent years, unless another be authorized by the Commissioner. For the purpose of this rule, a dealer in securities is a merchant of securities, whether an individual, partnership, or corporation, with an established place of business, regularly engaged in the purchase of securities and their resale to customers; that is, one who as a merchant buys securities and sells them to customers with a view to the gains and profits that may he derived therefrom. If such business is simply a branch of the activities carried on by such person, the securities inventoried as here provided may include only those held for purposes of resale and not for invsstment. Taxpayers who buy and sell or hold securities for investment or speculation, and not in the course of an established business, and officers of corporations and members of partnerships, who in their individual capacities buy and sell securities, are not dealers in securities within the meaning of this rule. A dealer in securities is not entitled to the benefits of section 200 with reference to the gain from the sale of securities.

Commissioner’s counsel has taken the position that the right of the partnership to inventory the stock in question turns on the faci-as to whether or not the stock was held as an investment or as a part of its stock in trade, and further, that the circumstances indicate that the stock was not held for sale. The taxpayers contend, however, that the stock of the Pine Street Corporation and of the Securities Corporation was held by Redmond & Co. only because no buyer could be found; and that even if the stock was held as an investment and not for sale it was properly included in inventory under article 1585, Redmond & Co. being a dealer in securities within the meaning of that article.

We are of the opinion that the position of the Commissioner with respect to the inventorying of the shares of stock of the Securities Corporation and of the Pine Street Corporation owned by Redmond & Co. is correct. The partnership was a dealer in securities. There is no evidence, however, that the partnership at any time offered the shares of stock of the two corporations above mentioned for sale. The contention of the petitioners that the company might or would have sold them if they could have gotten their price for them does not make them securities for sale in the ordinary course of business. The evidence does not warrant a finding that they constituted a part of the body of securities of the partnership held for sale. The circumstances under which the assets of both corporations were acquired and the corporations were organized all lead to the conclusion that the shares of stock of the corporations were not a part of the securities held for sale. They simply constituted an investment of Redmond & Co.

We are further of the opinion that the slow-moving securities that had been transferred or sold to the Securities Corporation were likewise not a part of the inventoriable securities of the partnership. Legal title to the securities transferred was in the Securities Corporation. If the business of that corporation was the purchase and sale of securities, the corporation itself would undoubtedly be entitled to inventory them. But the partnership which owned the shares of stock of the Securities Corporation, not having legal title .to the securities held by such corporation, could not inventory them.

There remains for determination the question whether Redmond & Co. is entitled to deduct from its gross income of 1918 the amount of the deficit in the operation of the Pine Street Corporation which it advanced to that, corporation during that year. The evidence indicates that it was the intention of both Redmond & Co. and the Pine Street Corporation to treat this transaction as a loan from the partnership to the corporation. The evidence does not indicate that it was paid as a part of an agreed rental. The petitioners claim that in effect it was in the nature of a rental. We are of the opinion, however, that there is no sound basis for such contention. Upon the record as made, the action of the respondent in disallowing the deduction from the gross income of the partnership is sustained.

No action will be taken concerning the deficiencies for 1919 and 1921 until after the final determination of the deficiencies for 1918 have been settled in accordance with this opinion.

Reviewed by the Board.

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

Green did not participate.

Trussell, Phillies, and Milliken dissent.


author: Love:

text:
    First State Bank of Brackettville, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 12876.
    Promulgated December 29, 1927.

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

      Harold Allen, Esq., for the respondent.

      Claude Pollard, Fsq., Attorney General of Texas, C. W. True-heart, Esq., and B. B. Cousins, Jr., Esq., as amici curiae.

   OPINION.

Love:

The petitioner takes the position that the amount levied and collected from it during 1920, for the maintenance of the Depositors’ Guaranty Fund (hereinafter called the Fund) is an ordinary and necessary business expense, and is, therefore, deductible.

The respondent, on the other hand, takes .the position that the amount so paid into the Fund is not deductible. In support of this position he urges, first, that if the amount in question should be classed as an expense, it does not constitute a necessary expense because under the State law the petitioner could elect to operate under the Fund or under another system, the depositors’ bond security system; and second, that while the petitioner gave up control of the amount paid into the Fund, that amount was impressed with a trust for the return or relinquishment to the petitioner, upon withdrawal from the plan of protection, of that portion of the amount so paid which had not been appropriated to carry out the purposes of the act creating the Fund. In other words, it is the respondent’s second contention that because of the petitioner’s undetermined reversionary interest in the Fund as of December 31, 1920, no part of the amount so paid in during 1920 can be classed as an expenditure, that is, a subtraction from gross income.

We are of the opinion that the respondent’s first contention is not, in view of the Texas statutes, well founded. Article 437, Revised Statutes of Texas, 1925, provides:

Protection of depositors. — Every banking institution except savings banks, incorporated under tbe banking laws of this State shall protect its depositors either by availing itself of the depositors’ guaranty fund, or by the depositors’ bond security system. A choice of one of the methods prescribed shall be exercised by the holders of the majority of the stock; and the president or cashier of such bank shall notify the Commissioner by registered mail of such action. No such institution shall be permitted to receive deposits until it shall have complied with the provisions of this chapter. (Acts, 1909, 2nd C. S. p. 406.)

It is clear, therefore, that in 1920, the petitioner, or any other state bank of Texas, had of necessity to elect one of the two methods of protecting depositors described by law before it could engage in the conduct of its business. The petitioner elected to operate under the Fund, and, as will be pointed out hereinafter, it was under legal compulsion to make certain payments thereto.

We are not concerned with the question as to which of the two methods of protecting its depositors was more advantageous to the petitioner or with the question as to the relative costs thereof. The fact remains that petitioner had to elect one of two methods as a condition to doing business, and its action in that respect must be re-, garded as the exercise of business discretion. The mere fact that it chose one method and not the other has no effect upon the element of business necessity. Clearly, therefore, if the amount paid in 1920 into the Fund can be classed as an expense, it constitutes a necessary expense.

There remains for our consideration, therefore, the question as to whether the amount paid into the Fund in 1920 was deductible expense incurred in conducting petitioner’s business.

The status of the amount paid by petitioner in 1920 into the Fund is fixed by the law of Texas then in force. Article 443, Revised Statutes of Texas, 1925, provides:

Assessments for fund: For the purpose of creating a Depositors’ Guaranty Fund, any bank or bank and trust company which shall elect to secure its depositors under the Guaranty Fund Plan if its application is approved by the State Banking Board, shall pay to said Board on January first an initial payment of a sum equal to one per cent of its average daily deposits for the year next preceding November first prior to the date of payment, and annually thereafter, one-fourth of one per cent of its average daily deposits for the preceding year ending on November first. Any bank or bank and trust company which shall not have been in operation for one year at the time of such initial payment, shall pay to the Board a sum equal to three per cent of its capital stock and surplus, which sum shall constitute a credit fund subject to adjustment at the end of one year, on a basis of its average daily deposits for the preceding year ending November first, as provided for other banks. In computing the aggregate amount of such average daily deposits, United States, State or other public funds if otherwise secured, and the deposits of its savings department as provided in Chapter Six of this title, shall not be included. When the amount available in said guaranty fund shall reach five million dollars, the Commissioner shall notify all banks and bank and trust companies subject to the provisions of this chapter of that fact at least thirty days before the next annual payment; and thereafter the banks and bank and trust companies participating shall not pay any further amount into said guaranty fund until it shall be reduced to a sum below five million dollars or below the amount of the guaranty fund on January first preceding. In the event of necessity to meet an emergency at any time, and not otherwise, the Banking Board shall have authority to require the payment for the current year of not exceeding two per cent of such daily average deposits, or such part thereof as may be necessary to restore said fund to the maximum above named, or to its amount as of January first preceding, or to meet the emergency. The first payment herein provided for by any bank or bank and trust company which shall hereafter elect to secure its deposits under the Depositors’ Guaranty Fund, shall be made by said corporation to said Banking Board without reference to said maximum amount in said Depositors’ Guaranty Fund. (Id.; Acts 1st C. S. 1921, p. 63.)

It will be observed that, by the above-quoted provision of law, the petitioner, having elected to operate under the Fund, was required to make definite contributions at periodical times of amounts prescribed by the statute, such amounts constituting the so-called annual assessments. In addition, the petitioner would, on call from the State Banking Board, have to pay other amounts, the limit of which is prescribed by law. Any amount paid, pursuant to call from the Banking Board, other than the annual assessments, constitutes the so-called special assessment.

The above-quoted provision of law provides for annual statutory assessments to create and maintain the Fund and it also provides for special assessments to replenish it. In any event the payments pursuant to either type of assessment are required by law to be made to the Fund. As hereinbefore stated, the amount, the deducti-bility of which is in dispute, was paid by petitioner pursuant to annual statutory assessment for 1920.

The method of paying amounts into the Fund is prescribed by law. Article 444, Eevised Statutes of Texas, 1925, provides:

Guaranty Fund,.- — The Depositors’ Guaranty Fund shall be paid to the State Banking Board as follows: each bank or bank and trust company shall pay twenty-five per cent of the payment required of it in cash. Such sum shall be deposited by the Board for safe keeping only, with the State Treasurer as bailee for the State Banking Board, and paid out by the Treasurer on warrants drawn by the order of said Board. Said fund shall never be diverted from the purpose specified in this chapter, nor shall it ever be considered State funds. The remaining seventy-five per cent of such payments shall be placed to the credit of the State Banking Board by each such bank or bank and trust company upon its books as a demand deposit subject to clieck upon the order of the Board. (Acts 2nd C. S. 1909, p. 406.)

From an examination of this provision, it will be observed that the amount paid into the Fund in 1920 by the petitioner pursuant to annual statutory assessment, passed out of its control and beyond its jurisdiction, and title thereto passed to the State Banking Board. Twenty-five per cent of the amount was required to be paid in cash to the State Banking Board and 75 per cent of it was required to be placed to the credit of the Banking Board, subject to its order or check. The amount credited on petitioner’s books therefore, became nothing more or less than a demand deposit of the Banking Board.

The Commissioner, however, in denying the petitioner the right to deduct the amount so paid into the Fund, takes the position that under the law of Texas the petitioner had a reversionary interest in the amount paid in and that inasmuch as the amount of such re-versionary interest was undetermined on December 31, 1920, no part thereof can be considered an expense for the reason that some or all of it may revert to petitioner.

It is true that at some unascertained time the petitioner might receive from the Fund some or all of the amount paid in in 1920. Article 445, Revised Statutes of Texas, 1925, provides:

Refunding to banks. — -In tbe event of the voluntary liquidation of any bank or trust company operating under the provisions of the Depositor’s Guaranty Fund, when it shall be made to appear to the State Banking Board that all depositors have been paid in full, said board shall return to such bank or trust company the pro rata part paid by it into such fund when unused. Or, in the event any bank or bank and trust company that has been operating as a guaranty fund hank shall have ceased to operate as a guaranty fund hank and adopted the bond security system under this chapter, its bond having been approved by the county jitdge and filed with the Banking Commissioner of Temas, as provided by law, said hom’d shall return to such bank or trust company the pro rata part paid by it into such fund when unused. (Acts 1925, p. 26, 39th Leg., ch. 9 P. 1.) (The portion in italics was added by amendment in 1925.)

It is clear, therefore, from the foregoing provision of law that during 1920 the petitioner was not entitled to any part of the amount paid into the Fund. As a condition precedent to the possibility of a refund, the petitioner would have to voluntarily liquidate and pay all of its outstanding obligations to all depositors in full. There was no statutory authority under which a refund could be made so long as petitioner continued to do business as a bank. It is equally clear that so long as the petitioner continued to do business, the Fund by reason of the failure of member banks might become depleted to such extent that petitioner’s reversionary interest in the amount paid in in 1920 would be entirely extinguished.

The ultimate facts concerning the amount paid in 1920 into the Fund by the petitioner are these: There was a fixed and definite liability on the part of the petitioner to pay into the Fund a definitely ascertainable amount, as prescribed by law. Upon the happening of a specified contingency, namely, voluntary liquidation, or in and after 1925, voluntary liquidation or change to the bond security system, the petitioner might recover all or part of the amount paid in, the amount recovered being dependent upon the condition of the Fund at that time.

We are of the opinion that the petitioner having paid the amount in question pursuant to a definite liability fixed by law, the contingent possibility of a refund of some or all of the amount so paid does not render the amount a nondeductible item. It seems clear that if the right to the deduction is denied the petitioner, its net income for the year in question could not be rightly determined. We are of the further opinion, therefore, that the amount paid into the Fund was an expense incurred and properly attributable in and to the conduct of petitioner’s business during the year 1920. See American National Co. v. United States, 274 U. S. 99. Our conviction that the amount so paid by the petitioner in 1920 into the Fund is deductible from gross income for that year, is fortified by the Board’s reasoning and decision in Hibbard, Spencer, Bartlett & Co., 5 B. T. A. 464. If the contingency ever arises upon which a refund is realized out of the payment made in 1920, the amount so realized should be treated as income for the year in which it is realized. •

We conclude, therefore, that the petitioner is entitled to deduct from gross income for the year 1920, the amount of $2,474.04, which amount was paid in that year into the Fund as the result of an annual assessment.

Reviewed by the Board.

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

Trammell and GreeN dissent.


author: Teammell :

text:
    Pilot Life Insurance Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10297.
    Promulgated December 29, 1927.

      John E. Walicer, Esq., and J. Gilmer Komer, Jr., Esq., for the petitioner.

      M. N. Fisher, Esq., for the respondent.
   OPINION.

Teammell :

No question is presented in this proceeding as to whether the reserve fund for deferred dividend policies was a reserve fund required by law, it being conceded in the respondent’s answer that it was such a reserve fund.

The petitioner contends that the amount of $98,815.56 was released from the reserve fund required by law in 1918, and under the decision of the Supreme Court in the case of Maryland Casualty Co. v. United States, 251 U. S. 253, the amount became taxable income in that year. It is then argued that since the amount was released from the reserve fund during 1918, when the amount was replaced in the reserve fund this constituted an addition to the reserve fund required by law.

We do not agree with the petitioner that the amount was released and became free assets in accordance with the decision in the case of Maryland Casualty Co. v. United States, supra. In that case -the court held that if the decrease in the reserves was due to an overestimate of reserves for the preceding year, with a resulting excessive deduction from income for such year, and the excess was released to the general uses of the company and increased its free assets in the succeeding year, then it might be treated as income to the extent of the amount released. The court used the following language:

But such deductions can be restored to income again only where it is clearly shown that subsequent business conditions have released the amount of them to the free beneficial use of the company in a real, and not a mere bookkeeping sense.

There is here no evidence that the reserve computed for 1918 was excessive. On the other hand, there is evidence that the amount of the particular reserve in question was correct. The Insurance Commissioner did not authorize the reduction upon the ground that it was unnecessarily large or excessive in amount or that it was not needed or required by law or the regulations of the Insurance Commissioner then in effect. It is shown that the only purpose of reducing this reserve was for the purposes of the report to the Insurance Commissioner and it was only in that respect, by the verbal permission of the Insurance Commissioner, that it was reduced. Wo are convinced that the reserve was not released to become free assets in any substantial sense of the word. The transaction merely amounted at most to a transfer from one reserve fund to another for temporary purposes or the temporary use for other purposes than those for which it was set aside, with the understanding and legal obligation that it was to be replaced, and the so-called release was not even a book entry. The only place the release appears of record was in the report to the Insurance Commissioner. Upon the books of the company it would appear that it was not necessary to set aside in 1919 the amount which was taken from the reserve merely for the purposes of the report to the Commissioner in 1918, because upon the books of the company the-amount of $98,815.56 remained in the reserve fund and no addition thereto of that amount, it seems, could have been made upon the books or was in fact so made. The deduction on account of the addition to the reserve fund in the amount of $98,815.56 in 1919 was predicated upon the claim that the reserve to that extent had been released in 1918. We do not think it was released in 1918 as contemplated by law. The reserve was not used for the purpose for which it was created or set aside but was still required for that purpose. The fact that the Insurance Commissioner verbally permitted a report to be filed which did not correctly reflect the books or the actual facts respecting the reserve theretofore required does not alter the tax liability.

On the other hand, if it was an actual release of the reserve fund when the report to the Insurance Commissioner for 1918 showed the release of such fund, this report was not completed or made until February, 1919. Since it was released at no other place, it would seem to follow that it was not released until 1919, if at all. Conceding, however, for the purpose of argument, that it was released in accordance with law, then it is only the net additions to the. reserve fund, that is, the additions in excess of the reductions, which are permitted to be taken as deductions in determining net income. Both of these transactions having occurred in 1919, the only net addition would be the $22,399.19 which was allowed by the respondent.

In view of the foregoing, it is our opinion that the petitioner is not entitled to the deduction claimed as a net addition to the reserve fund required by law.

Reviewed by the Board.

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


author: Teussell:

text:
    Sunnyside Coal & Coke Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9442.
    Promulgated December 29, 1927.

      John E. MoOT/u/re, Esq., for the petitioner.

      Grwrwüle 8. Borden, Esq., for the respondent.
   OPINION.

Teussell:

As regards the issue of depreciation, we are of the opinion that the testimony furnished by the petitioner does not support petitioner’s claim either for accelerated depreciation or obsolescence. We are also convinced that the record as made fails to support the affirmative allegations made in the respondent’s amended answer, and we, therefore, conclude that the computations made by the respondent, the results of which are shown in the deficiency letter, provide for the period under consideration an entirely reasonable allowance for depreciation of the properties involved and that the Commissioner’s determination as set forth in his deficiency letter should not be modified, and that the 8 per cent rate used furnishes in all respects a reasonable allowance. The testimony concerning the asset item here under consideration also fails to support the affirmative allegations of the Commissioner’s answer that invested capital should be modified on account of prior exhaustion of this asset account.

The petitioner began mining coal from its so-called fee property in the year 1915. During the year 1915 the petitioner was entitled to a deduction for depletion under the provisions of the Revenue Act of 1913, section II, subdivision G (b) (second) — ■

* * * All losses actually sustained within the year and not compensated by insurance or otherwise, including a reasonable allowance for depreciation by use, wear and tear of property, if any; and in the case of mines a reasonable allowance for depletion of ores and all other natural deposits, not to exceed 5 per centum of the gross value at the mine of the output for the year for which the computation is made; * * *.

During the calendar years 1916 and 1917 the petitioner was entitled to depletion deductions under the provisions of the Revenue Act of 1916, section 12, subdivision (b), second—

* * * (b) in the case of mines a reasonable allowance for depletion thereof not to exceed the market value in the mine of the product thereof wffich has been mined and sold during the year for which the return and computation are made, * * *.

For the subsequent periods of January 1, 1918, to the close of the fiscal year here under consideration the petitioner was and is entitled to deductions for depletion under the provisions of the Revenue Acts of 1918 and 1921, section 234 (a) (9)- — •

In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable • allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each ease, based upon cost including cost of development not otherwise deducted: Provided, That in the case of such properties acquired prior to March 1, 1913, the fair market value of the property (or the taxpayer’s interest therein) on that date shall be taken in lieu of cost up to that date: * * *.

The comparable section and provisions of the Act of 1921 are in substantially the same language as the above quoted portion of the Act of 1918.

The respondent has applied the unit of depletion found under the provisions of the 1918 Act to the coal mined in the calendar years 1915 and 1916 and set up a hypothetical depletion reserve for those years based upon that computation. For the period from January 1,1917, to April 80,1917, he has allowed a depletion deduction in the amount of $1,566.78, and for the fiscal year ended April 30, 1918, in the amount of $6,240.95. For the following years he ha's applied the unit rate of 3.2677 cents upon the coal removal. He thus found that an allowance for depletion in the year ended April 30, 1921, in the amount of $704.71 completes the total of the March 1,1913, value.

In making this computation the Commissioner appears to have entirely overlooked the fact that under the 1913 Act the petitioner was entitled to a depletion. deduction upon an entirely different basis from that provided in the Acts of 1918 and 1921, and that for the calendar years 1916 and 1917 the petitioner was again entitled to depletion deductions upon an entirely different basis than under the 1913 Act or the subsequent Acts of 1918 and 1921.

Under the provisions of the Acts of 1913 and 1916 the amount which a taxpayer was entitled to recover through depletion was wholly different under each of said Acts as well as under the Acts of 1918 and 1921, and we are of the opinion that the amounts allowable under the 1913 and 1916 Acts whether greater or less than the amounts allowable under the later Acts should not be permitted to limit the depletion deductions authorized by the Acts of 1918 and 1921. And, if it may be that under the 1913 and 1916 Acts an amount may have been allowed as a deduction greater than the amount authorized by law, the remedy is in seeking a revision of the tax returns for those years and not in depriving the taxpayer of his authorized deduction under the 1918 and 1921 Acts. Cf. United States v. Ludey, 274 U. S. 295; 47 Supreme Court 608, 611, where the court said:

* * * If in any year he has failed to claim, or has been denied, the amount to which he was entitled, rectification of the error must be sought through a review of the action of the bureau for that year.

On March 1, 1913, the petitioner owned coal in the ground in the amount of 447,000 tons. Prior to May 1, 1920, the petitioner had removed 307,698 tons of tbis same coal. During its fiscal year ended May 31,1921, it had removed 74,760 tons of this same coal and under the provisions of the Revenue Acts of 1918 and 1921, the petitioner is entitled to a deduction for each ton of coal mined in an amount based upon the agreed March 1, 1913, value, which amount is 3.2677 cents per ton.

The respondent’s elimination of $16,407.19 from invested capital was erroneously made. The March 1, 1913, value of a capital asset has no relation to the computation of invested capital and in the situation here presented the petitioner’s asset item of coal lands and coal rights should be reflected in invested capital for the fiscal year ended April 30,1921, in the amount of their cost, which we have found to be $32,254.09, but against which there should be charged the amount of a depletion reserve found by applying the cost per ton of the original estimated coal content of the mine to the number of tons removed, but in no event greater than the amount of depletion actually allowable as deductions from gross income during the years of operation.

The deficiency should be recomputed in accordance with the foregoing opinion.

Reviewed by the Board.

Judgment utill be entered upon 15 days’ notice, pursuant to Rule 50.


text:
    Celluloid Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 8543, 19459.
    Promulgated December 29, 1927.

      B. Kemp Slaughter, Esg., and H. 0. Bickford, Esq., for the petitioner.

      M. N. Fisher, Esq., for the respondent.
   OPINION.

Smith :

In Docket No. 8543, covering the years 1918 and 1919, the petition alleges errors on the part of the Commissioner as follows:

(4) The determination * * * is based on the following errors:
(a) The Commissioner of Internal Revenue failed to allow as a deduction from gross income the loss amounting to $41,711.57 claimed by taxpayer as obsolescence and loss of useful value on structure and machinery.
(b) The Commissioner failed to allow as a deduction from gross income a sufficient amount to reasonably cover the loss sustained by the company by reason of wear and tear and obsolescence.

In Docket No. 19459, covering the year 1920, the petition alleges errors as follows:

4. The determination * * * is based upon the following errors:
(a) The Commissioner failed to allow as a deduction an amount sufficient to cover the losses due to depreciation and to obsolescence and loss of useful value of structures and machinery.
(b) The amount used, in computing gross income, as the inventory as of December 31, 1920, was erroneous inasmuch as the amount included therein for certain goods hereinafter described was greatly in excess of the actual market value of such goods at that date.
(c) The total of sales used in computing gross income included billings to customers of large quantities of unmarketable goods manufactured by an experimental process, which was a failure, which goods the customers rejected and returned to the petitioner, so that the sales were never consummated and the assumed profit on the same never had any actual existence, and the cost of manufacture was almost or quite a total loss.

This petition further alleges that in lieu of a deduction on account of obsolescence of structure and machinery in the amount of $41,-711.57 claimed in the petition filed for the years 1918 and 1919 (Docket No. 8543), there should be allowed as a deduction from gross income on account of obsolescence for the years 1919 and 1920 the sums of $20,420.71 and $5,877.82, respectively.

After the petitions were filed the petitioner prepared a statement (Table No. 1, supra) showing the property on which a deduction for obsolescence is claimed, together with its date of acquisition, cost, percentage of depreciation reserve from date of erection to January 1, 1919, amount of depreciation from date of acquisition to January 1, 1919, and net book value on January 1, 1919. At the hearing counsel for the petitioner withdrew assignment of error (4) (b), Docket No. 8543, and stated that the above-mentioned statement set forth specifically and in detail the subject matter of allegations (4) (a) Docket No. 8543, and 4. (a) Docket No. 19459. He also asked that the various amounts claimed as deductions for obsolescence in the two petitions be subject to amendment so as to conform to the facts that would be introduced in evidence.

Counsel for the respondent stated that his understanding of peti-, tioner’s position with respect to claimed deductions on account of depreciation and obsolescence was that there should be deductions for 1919 and 1920 on account of obsolescence of property properly spread to the two years, and also that there should be allowed in one or both of the years losses on account of definite abandonment-of property.

Having given due consideration to the statements appearing in the petitions and in the petitioner’s brief, and having considered such allegations in the light of the position taken by counsel for both parties at the hearing, we take it that the issues before us are, (1) whether the petitioner is entitled to a deduction from gross income for each of the years 1919 and 1920 on account of losses due to obsolescence and loss of useful value of structure and machinery; (2) whether the value of the closing inventories for the year 1920 should be adjusted on account of defective goods contained therein; and (3) whether the accounts receivable account as of December 31, 1920, should be adjusted on account of billings to customers contained therein covering defective goods which were returned after the close of the taxable year.

The allegation of petitioner that the respondent erred in refusing to allow certain deductions for obsolescence being common to both of the appeals considered here, they were, on motion of the petitioner which was duly granted, consolidated and heard together. This issue, being the only one raised with respect to the year 1919, will be disposed of first. No issue was raised with respect to the year 1918 and the Commissioner having determined an overassessment for that year the Board is without jurisdiction of so much of the appeal as pertains thereto. Appeal of R. P. Hazzard, Co., 4 B. T. A. 150, and Appeal of Cornelius Cotton Mills, 4 B. T. A. 255.

Section 234(a) of the Revenue Act of 1918 provides:

That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
*******
(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise;
*******
(7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.

The property covered by petitioner’s claim consists of (1) machinery used in the manufacture of photographic film base, (2) machinery used in the manufacture of celluloid, and (3) a portion of the building in which the manufacture of film base is carried on. While neither the record nor petitioner’s brief clearly sets forth upon which of the above-quoted provisions of the statute the petitioner bases its claim for a deduction for the year 1919, no evidence was presented to show that during that year it sustained losses within the meaning of subdivision (4), supra. On the contrary, the evidence is clear that there was no discarding or abandonment of the property in question during 1919. Consequently it is apparent that no deduction for the year 1919, based upon the provisions of section 234(a) (4) of the Revenue Act of 1918, would be allowable.

We conclude, therefore, that petitioner’s claim for a deduction for the year 1919 is based upon the provisions of subdivision (7) of section 234(a) of the Revenue Act of 1918. This conclusion is supported by the introduction of testimony at the hearing to show (1) that plans were made in 1919 which would necessitate the abandonment in 1920 of the wheels installed in 1909 and 1910 for use in the manufacture of film base, together with certain complementary machinery; (2) that changes were made in the formula employed in the manufacture of celluloid in 1919 which would necessitate the abandonment in 1920 of the machinery used in making celluloid; and (3) that the plans made in 1919 for the abandonment in 1920 of a portion of the machinery used in making film base would also result in the abandonment of that part of the building in which such machinery was housed.

As a result of years of experimentation and development by the petitioner a type of machinery peculiarly adapted to the manufacture of film base was evolved. The first installation of such machinery was made in 1911 and as demand for film base increased subsequent installations of the same general type were made in 1914 and in 1920. While the recommendation of the superintendent of film manufacture, dated October 15, 1919, contemplated the removal of the wheels installed in 1909 and 1910, as well as the installation of additional wheels of the same type as those installed in 1911 and 1914, the president, under date of December 2, 1919, authorized only the installation of the additional wheels. He did not approve that portion of the recommendation relative to the removal of the wheels installed in 1909 and 1910.

The machinery in use prior to 1911 was either discarded or abandoned in 1920, so that to-day all film base is made by the use of machinery installed in 1911, 1914, and 1920. It is evident that long prior to 1919 the petitioner considered the type of machinery erected in 1911 was best suited to its needs and the superintendent of film manufacture testified that in his opinion the machinery installed in 1909 became obsolete in 1911 when the new type of machinery was erected.

Eelative to the machinery used in the manufacture of celluloid, the testimony is clear that when the formula was changed in 1919 it became apparent that the use of a substitute in the place of camphor would necessitate the use of machinery different from that previously employed in making celluloid. It is equally clear, however, that a wide divergence existed in the opinions of various plant executives relative to the advisability of using the camphor substitute on a large scale. - The management relied on the assurances of the chief chemist that the camphor substitute had been perfected, and ordered the superintendent of manufacture to employ the new formula to a large extent. The superintendent protested against the use of a substitute, claiming that its use would result in the production of an inferior product. Due to the fact that use of the substitute did result in the production of inferior celluloid its use was discontinued in the latter part of 1919, and it was not until the latter part of 1920 that the use of a substitute was resumed. Consequently, it does not appear that in 1919 the petitioner definitely knew that this machinery would be subsequently superseded by other machinery adapted to the manufacture of celluloid in which a substitute for camphor was used, or that the machinery in question became obsolete in that year.

While certain plans and changes affecting both the manufacture of film base and celluloid were made in 1919 which occasioned the abandonment in 1920 of certain machinery used therein, the evidence does not show that such machinery and that portion of the building in which it was housed became obsolete in 1919. Nor has the petitioner alleged that the respondent committed error in computing the allowance for exhaustion, wear and tear of its property with respect to the year 1919. No deduction, therefore, in addition to that allowed by the respondent can be allowed for that year under the provisions of section 234(a) (7) of the Revenue Act of 1918.

The next question for determination is the amount of the loss, if any, deductible from gross income for the year 1920 as a result of the discarding of certain machinery and equipment. The evidence shows that the wheels had no value for any purpose whatever after they were dismantled in 1920. The evidence also shows that the machinery and equipment which was an integral part of the manufacture of film base connected with those wheels was also valueless at the date of abandonment in 1920. It also shows that the machinery left in the converting department (items 14, 15 and 16, Table 1) was valueless at the date discarded in 1920. Petitioner is entitled to deduct from the gross income of 1920 the depreciated cost of these assets. Monroe Cotton Mills v. Commissioner, 6 B. T. A. 172, and cases cited therein. Although the use of the machinery and equipment designated as items 17, 18, 19 and 20 (Table 1), was discontinued in 1920, the evidence does not show that these assets were valueless at that date. One witness testified that the Downingtown beating engine and the Miller duplex beating engine had a value of approximately $650 in 1927 and that the value in 1920 was not in excess of that amount. 'The latter engine was almost new. A discontinuance of the use of machinery alone does not prove a loss in respect of the machinery. Upon the evidence the claim of the petitioner for a loss deduction in respect of these assets is not sustained.

With respect to a loss of seven-sixteenths of the cost of the* building in which the discarded film wheels were located, W. F. Crawford, a witness for petitioner, testified as follows:

Q. Mr. Crawford, you have testified that this property, this particular equipment and structures, too, because the structures were no longer of value, were abandoned February 8, 1920?
A. Yes.
Q. What do you consider was the value of these structures, and that equipment, as of February 8, when you permanently abandoned it?
A. For the purpose of making film those wheels were of no value. By cutting the building, ripping out partition walls and foundations and cutting larger openings in the outside wall, it would be possible to install the large wheels. That was contemplated as part, of this project.
Q. Would the cost justify the expense?
A. That is an open question, because of the fact that concrete was used in part of the structure and was heavily reinforced. I am not sufficiently expert as a building designer to state whether or not it would pay, because of the handicaps that would be involved in getting these tremendously heavy machines in place through the side wall.
Q. So that substantially as they stand — even to-day they have no value?
A. They are of no value for the purpose for which they were erected.
Q. And since they occupy the structure, the structure is of no value; is that correct?
A. That is correct.

After carefully weighing this evidence we conclude that the use of this portion of the building for the purpose for which it was erected was terminated in 1920 and not that it became useless for all purposes and was abandoned in that year as valueless. The claim of petitioner for the deduction of this loss is likewise not sustained.

From the evidence submitted there can be little doubt that petitioner’s inventory on December 31, 1920, contained a great quantity of defective material which had been erroneously classified as “ firsts ” and “ seconds,” resulting in an over-valuation of the inventory. Nor can there be much doubt that the reinspection of the material contained in the inventory together with the method employed in reclassifying it enabled the petitioner to determine the proper grade for each kind of material contained therein. Since the inventory had been originally valued at cost or market, whichever was lower, we are of the opinion that the petitioner was entitled to revalue it by assigning to the reclassified material the corresponding unit costs or market values employed in the original valuation, and that the deficiency for the year 1920 should be recomputed on the basis of the reclassified inventory. Appeal of Champion Stove Co., 1 B. T. A. 656.

The third issue relates to the right of petitioner to reduce the amount of its accounts receivable account as of December 31, 1920, in the sum of $128,379.21. This amount was reflected in the accounts receivable account as at December 31, 1920, and represents the value of defective goods returned in the first four months of 1921 but which had been sold and delivered in the year 1920. The evidence shows that returns of defective goods, both in the latter part of 1920 and in the early part of 1921, were greatly disproportionate to normal returns for a like period in prior years, and a firm of certified public accountants estimated shortly after the close of the year 1920 that the accounts receivable account as at December 31, 1920, reflected approximately $100,000 worth of goods which, in all probability, would be returned.

The question as to the propriety of accruing a liability that, is wholly anticipatory has been before us on numerous occasions and we have held that the accuracy with which the amount of the liability may be predetermined does not affect the question, which must be answered solely in the light of whether the liability is certain or contingent. In the instant case, as in the Appeal of Morrison-Ricker Manufacturing Co., 2 B. T. A. 1008, none of the goods were returned in the taxable year. The decision in that case is controlling here and no reduction of the accounts receivable account as of December 31, 1920, may be allowed.

Keviewed by the Board.

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

MtjRdock concurs in the result.

Sternhagen dissents in part.

Phillips dissents on the first point.