Security Flour Mills Co. v. Commissioner , 45 B.T.A. 671 ( 1941 )

THE SECURITY FLOUR MILLS COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Security Flour Mills Co. v. Commissioner

Docket No. 90137.

United States Board of Tax Appeals

45 B.T.A. 671; 1941 BTA LEXIS 1087;

November 12, 1941, Promulgated

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">*1087 1. Petitioner, after receiving in 1936 a substantial amount of processing taxes impounded in court prior to invalidation of the act under which such taxes had been imposed, reimbursed some of its vendees for a portion of the processing tax which had been included in the price of wheat products sold to them in 1935. Held, following Cannon Valley Milling Co.,44 B.T.A. 763">44 B.T.A. 763, that the amounts so paid to vendees are deductible in computing petitioner's net income for 1935.

2. Under a closing agreement, executed in 1939, settling petitioner's liability for tax on unjust enrichment and its claim for refund, a portion of the processing tax, which had been deducted from gross income for 1935, was refunded. Held, following E. B. Elliott Co.,45 B.T.A. 82">45 B.T.A. 82, that, inasmuch as the year 1935 is open, adjustment of the deduction for taxes should be made for that year.

Robert C. Foulston, Esq., Harry E. Lunsford, Esq., and Vincent A. Smith, C.P.A., for the petitioner.

R. P. Hertzog, Esq., and J. Y. Porter, Esq., for the respondent.

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MELLOTT

">*671 The Commissioner made several adjustments to the net income">*1088 reported by petitioner in its income and excess profits tax return for the calendar year 1935 and determined a deficiency in the aggregate amount of $17,791.28, $14,702.48 being income tax and $3,088.80 excess profits tax. In an amended answer he asserts a claim for an increased deficiency alleging that the correct amount is $18,288.02, of which $15,066.75 is income tax and $3,221.27 is excess profits tax.

">*672 Several of the adjustments made by the respondent are conceded by petitioner to be correct. The issues to be decided arise in connection with certain processing taxes. Between May and December in 1935, processing taxed amounting to $105,054.70 were accrued upon petitioner's books and deducted in computing its income. Most of this amount had been impounded under order of court and, during the succeeding taxable year, was returned to petitioner following a judicial determination that the processing tax act was invalid. During 1936, 1937, and 1938, $45,865.90 was paid over by petitioner to its vendees to reimburse them for the processing taxes which they had paid to petitioner and which petitioner had not been required to pay over to the Government. The first question">*1089 is whether the sum of $45,865.90 constitutes, and may be allowed as, a deduction from petitioner's gross income for 1935. The second question is whether petitioner's tax liability for 1935 may be increased by reason of a closing agreement, executed by the parties in April 1939, under section 506 of the Revenue Act of 1936, settling petitioner's liability for unjust enrichment tax under Title III and its claim for refund under Title VII of said act.

The proceeding was submitted upon a stipulation of facts, oral testimony, exhibits, and a supplemental stipulation of facts. All facts contained in the stipulations are found to be as stipulated, whether specifically set out in our findings or not. From the whole record we make the following findings of fact.

FINDINGS OF FACT.

Petitioner is a corporation organized and existing under the laws of the State of Kansas, with its principal place of business at Abilene, Kansas. It filed a corporation income and excess profits tax return for the year 1935 in which it reported its net income on the accrual basis.

At all times material hereto petitioner was engaged in the manufacture and sale of wheat flour. It was a first domestic">*1090 processor of wheat and, as such, was subject to the processing tax levied under the Agricultural Adjustment Act at the rate of 30 cents per bushel of clean dry wheat processed between July 9, 1933, and January 6, 1936.

During the period from January 1, 1935, to May 1, 1935, petitioner paid to the collector of internal revenue certain processing taxes (not in issue herein) and claimed and was allowed the amount so paid as a deduction from gross income in its Federal income tax return for the year 1935.

On June 29, 1935, petitioner caused to be instituted, in the District Court of the United States for the District of Kansas, a suit seeking ">*673 to enjoin the further collection from it of processing taxes levied under the authority and provisions of the Agricultural Adjustment Act. The court granted a temporary injunction on July 24, 1935, effective from May 1, 1935, enjoining the further collection from the petitioner of processing tax on condition that it file information returns with the collector and deposit in a bank, designated as the depository of the court, a sum of money equal to the tax shown to be due by such returns, pending the final determination of the constitutionality">*1091 of the act imposing the tax. Pursuant to such order and during the period May 1 to December 31, 1935, petitioner paid into the designated bank the total sum of $93,974.40 and, for the final month of said period, accrued upon its books as a liability for the processing tax, but did not pay to the collector or to the depository of said court, the sum of $9,896.66, plus an additional item of $1,183.64 representing a reserve for possible increases in the processing tax for prior years.

On February 28, 1936, following the invalidation of the Processing Tax Act by the Supreme Court on January 6, 1936 (United States v. Butler,297 U.S. 1">297 U.S. 1), the District Court of the United States for the District of Kansas entered an order making permanent the temporary injunction theretofore granted and directed the depository bank to pay over to petitioner the sum of $93,974.40 theretofore deposited by it pursuant to the court's earlier order. This order was complied with and the said sum, on February 28, 1936, was paid to petitioner.

After the invalidation of the Processing Tax Act by the Supreme Court certain of petitioner's vendees filed intervention petitions in the injunction">*1092 proceeding, seeking to have the impounded moneys returned to them. These petitions were resisted by petitioner upon technical grounds. The intervening petitions were denied on February 28, 1936.

During the calendar year 1936 petitioner, in its books of account, credited the processing tax returned to it pursuant to the order of the District Court to an account designated "Reserve for Processing Tax, Claims, etc." A summary and detailed analysis of this account is attached to one of the stipulations as an exhibit. Briefly, it shows total credits of $105,254.70 and debits of an equal amount, the last debit reflecting a transfer to surplus on June 30, 1939, of $30,289.99. Other debits were made to the account between January 1, 1936, and June 30, 1939, for legal fees, accounting fees, court costs, payment of Title III tax and reimbursements to vendees on shipments of flour made during the injunctive period. A summary of the last mentioned item shows $2,475.03 paid in 1936, $41,879.50 paid in 1937, and $1,511.37 paid in 1938.

After the injunction had been made permanent and the money which had been impounded had been released to petitioner, certain of ">*674 its vendees">*1093 instituted suit against it, claiming to be entitled to $1.38 per barrel of flour purchased by them during the injunctive period. The action was founded upon the Miller's Federation Uniform Sales Contract and upon quasi contractual and equitable trust fund theories. The suits were resisted and ultimately dismissed.

Petitioner's sales of flour from May 1 to December 31, 1935, were made at a stated price ber barrel. The selling price consisted of the usual items of cost, plus normal profit, and included in addition an amount sufficient to cover the processing tax. The invoice reflected the contract price, but did not show the tax as a separate item. The contract price was included in the gross sales entered on petitioner's books. More than 50 percent of such sales were made under the Miller's Federation Uniform Sales Contract referred to above. The pertinent reference to processing taxes in the contract is as follows:

The price named in this contract includes all taxes as at the date hereof proclaimed by the Secretary of Agriculture by virtue of the authority vested in him by the Agricultural Adjustment Act. * * * Under said Act it is provided that said taxes may be changed">*1094 from time to time. It is recogeized * * * that there is a growing tendency on the part of the United States and the separate states to tax grain * * * used in connection with the manufacturing, processing, blending, sale or distribution thereof. It is therefore, agreed * * * that if, after the date of this contract, the commodities * * * used in connection with the manufacturing, processing, blending, sale or distribution thereof, shall become subject to any increase in taxes or to any new or additional tax or taxes other than those included in the price hereof, (if the seller shall be required by law to collect such increases or additional taxes) * * * said increases or additional taxes shall be added to the price hereof; and correspondingly if any tax included in the price hereof shall be decreased or abated, then in that event, said decrease or abatement shall be deducted from the price hereof.

Petitioner had been advised by counsel as early as July 1935 that the Government intended, if the act should be held invalid, to recapture by new legislation a large part of the unpaid processing taxes, and that it would be inadvisable to make any commitments to refund any definite amount">*1095 or any percentage of the tax to its customers, since by agreeing to do so it might seriously impair its financial condition. On June 22, 1936, Congress enacted the Revenue Act of 1936, providing in Title III for the imposition of the unjust enrichment tax and in Title VII for the refund of taxes paid under the Agricultural Adjustment Act. Petitioner's counsel sought a ruling by the Treasury Department on the question whether the Miller's Federation Contract was an agreement, within the meaning of Title III, entitling petitioner to credit against its taxes under that title for any refunds made to vendees under Title VII. In the meantime counsel continued to advise petitioner not to make any definite ">*675 commitments to its customers with reference to refund of the processing tax to them.

The petitioner, pursuant to the advice of its counsel, refrained from making any definite promises respecting refunds in all written communications to its vendees. After the suit for injunction had been filed, and up to the latter part of 1936, petitioner, through its officers, salesmen, and brokers, orally informed some of its vendees that it proposed to make an agreement with them as">*1096 soon as all matters with respect to the impounded fund and unpaid taxes should be finally settled. It was stated that petitioner would treat them fairly and do as well by them as other mills similarly situated, but that no promise could be made to refund any definite amount to them. Petitioner considered the tax clause of the Miller's Federation Contract to be applicable only to increases or decreases in the price between the date of the order and the date of shipment and not as creating any obligation to refund part of the price in case of invalidation of the act. The above promises of fair treatment were made independently of that clause. They were made without approval of counsel, who intimated that they might be construed as creating a legal obligation.

In November 1936 petitioner informed some of its vendees, who had purchased flour under the Federation Contracts, that it intended to seek a final determination of its tax liability by the Treasury Department, and, after the amount of unpaid processing taxes passed on to vendees on which it would be subject to tax had been fixed, that it would seek permission to refund the whole of such amount to vendees, provided the Department">*1097 would accept such repayment as an offset against "Windfall", income, and excess profits tax liabilities and provided the vendees would accept such amount in satisfaction of their claims. The petitioner was informed by its counsel later in 1936 that the Treasury Department had agreed to allow credit for reimbursements and that it should proceed to make settlements with its vendees. Petitioner thereupon commenced negotiations with some of its vendees and made agreements with some of them as to the amount to be repaid to them.

During 1936, 1937, and 1938 drafts in various amounts were issued by petitioner to the vendees with whom agreements were made, aggregating (together with credits against the accounts of some of them) $45,865.90 ($2,475.03 in 1936, $41,879.50 in 1937, and $1,511.37 in 1938). Attached to each draft and made a part of it was a "Release Agreement", which, after referring to the difficulty of determining the exact amount of the processing tax which had been borne by the vendor and the vendee, recited that "the amount of the taxes shifted to vendee * * * was not more, and may be less ">*676 than" the total of the draft and credit memorandum referred to in the">*1098 agreement. By cashing the draft the vendee acknowledged full payment and satisfaction of, and discharged the vendor from, all demands, charges, claims, actions, and rights of action growing out of amounts paid on account of processing tax during the injunctive period and included in or added to the price of flour sold by the vendor to him; covenanted that he was the actual purchaser of the flour and the owner of the claim, that he was not a party to any pending action against the vendor, and that he had not authorized the institution or prosecution of any suit or action against it. The agreement also stated that nothing therein was to be construed as, or constitute an admission of, liability of the vendor to any other person, firm, or corporation and that all legal and equitable defenses, of which it might be possessed, in any and all pending and future litigation against it, were expressly reserved.

Petitioner did not make refunds to all who had purchased flour from it during the injunctive period. Refunds were made to some customers who had purchased under Miller's Federation Contracts, irrespective of whether or not they had been promised fair treatment. In making refunds">*1099 only regular customers were considered, and a large number of casual customers, or customers toward whom the petitioner felt no obligation, were ignored. The petitioner made no attempt to effect settlements with those to whom the promises to treat fairly had been made but who had not purchased under the Miller's Federation Contracts.

On a schedule attached to petitioner's income tax return for the year 1935 petitioner deducted from the amount of $908,613.29 shown as "Gross Sales, per Books", the amount of $106,604.02 as "Provision for allowances to Vendees of Processing Taxes." It added the amounts of the impounded funds returned to it in 1936 and accrued processing taxes which had not been paid, namely, $103,887.54, reporting the resulting figure of $905,896.81 as "Net Sales." The amount of $908,613.29 represents the amount arrived at after deducting from total gross sales amounts aggregating $163,526.21 representing estimated processing taxes collected from vendees during the year. Petitioner's total gross sales for 1935 were the aggregate of the two last mentioned amounts of $1,072,139.50. The sum of $163,526.21 deducted from petitioner's gross sales in its books of account">*1100 included, among other items, the $93,974.40 impounded in the depository and the $9,896.66 accrued upon petitioner's books as processing taxes for the month of December 1935 but not impounded or paid over to the Treasury Department.

In determining the deficiency the respondent disallowed as a deduction $105,054.70, consisting of the following items:

Processing taxes impounded and later (Feb. 1936) released to petitioner	$93,974.40
Accrued processing taxes Dec. 1935. Not impounded or paid over to treasury	9,896.66
Estimated processing reserve set up to provide for additional assessments for prior years	1,183.64
	105,054.70

">*677 The petition assigns error in the disallowance of $101,783.89 of the above amount as a deduction.

The income tax returns of petitioner for 1936 and 1938 are not in evidence, and the record does not show whether the payments to customers of $2,475.03 and $1,511.37 in those years were claimed as deductions, or whether they were allowed or disallowed by the respondent. Petitioner's income tax return for 1937 shows a net loss of $66,944.25, computed by including in the deductions claimed the sum of $43,390.87 representing payments">*1101 to customers in that year in settlement of processing tax claims.

Pursuant to the provisions of Title VII of the Revenue Act of 1936, petitioner filed a claim for the refund of processing taxes paid for the period July 9, 1933, to May 1, 1935. This claim was considered by respondent in connection with a settlement of petitioner's tax liability under section 506 of the Revenue Act of 1936. Petitioner and respondent, under date of April 8, 1939, executed a closing agreement under section 506, supra, wherein they agreed:

* * * that the total liability of the taxpayer for tax, penalty and interest under the provisions of Title III of the Revenue Act of 1936 [for taxable years ended prior to January 1, 1938], and the total amount with interest thereon, allowable to the taxpayer as a refund of amounts paid as tax under the Agricultural Adjustment Act, as amended, shall be finally settled * * * by the payment of * * * $16,405.33 by the taxpayer.

The computation made in connection with the closing agreement discloses a net unjust enrichment tax liability under Title III for 1935, 1936, and 1937, of $36,880.21, a refund under Title VII of $20,474.88, and a net tax payable of">*1102 $16,405.33. Notice and demand for payment in accordance with the agreement was mailed to the petitioner on April 27, 1939, and the liability of $16,405.33 was paid on May 2, 1939. The sum of $2,649.25 represented processing taxes paid by the petitioner during 1935 and was a part of the deduction claimed for such taxes in its income tax return for that year and allowed in determining the deficiency.

OPINION.

MELLOTT: The findings are more comprehensive than would seem to be required under the issues as stated by us in the beginning. The pleadings, stipulations, evidence, and opening brief of petitioner ">*678 indicate that we are being called upon to decide whether petitioner properly excluded $106,604.02 from its gross receipts in 1935. The first section of its opening brief concludes: "It is submitted that $106,604.02 of petitioner's 1935 'gross receipts' did not constitute income until the controversies relating thereto were determined in 1937." Petitioner's argument may be summarized as follows:

At the end of the taxable year 1935 it had accrued upon its books $105,054.70 as processing taxes. When the act was declared invalid (January 6, 1936) this amount was restored">*1103 to income. It says: Since, instanter such unconstitutionality was declared, there accrued or vested a substantial possibility that $1.38 per barrel of flour sold (not "processed") during the injunctive period would have to be disbursed either to customers or to the Government, the amount of $106,604.02 - the estimated amount which it might be required to repay - was set up on its books, held "in abeyance" or in a "suspense account", and excluded from gross income in its return for 1935. Then, says petitioner, in 1937 the controversies as to these moneys were substantially resolved, whereupon it made reimbursements to its customers totaling $45,865.90 with respect to its 1935 sales. It "then recognized as income, for the first time, all of its 1935 gross receipts except the $45,865.90 thereof which it had refunded to customers. It * * * is not now asking that its income be computed upon the basis of actual income less * * * [the $105,054.70]. * * * It asks to be permitted to deduct only such reimbursements as it actually made to its vendees." (The quotations are from petitioner's reply brief.)

">*1104 Before passing to what seems to be the real issue to be decided on this phase of the proceeding - i.e., the deductibility of $45,865.90 from petitioner's 1935 gross income - it may be stated that petitioner relies upon Commissioner v. Brown, 54 Fed.(2d) 563; certiorari denied, 286 U.S. 556">286 U.S. 556, as authorizing it to set aside the entire $106,604.02 in a "suspense account" and in refusing to include it in gross income because "a taxpayer is not required to report as income that which he may never be permitted to retain * * *." It points out that the moneys received by it upon the consummation of the injunction suit were "hot moneys"; that it was reasonably certain petitioner would be unable to retain them; that it was legally obligated to repay an equitable portion to its vendees; that it never asserted any claim of absolute ownership to the fund, but treated it as a "suspense account"; and that under the accrual method of accounting such moneys did not become income until all controversy as to their ownership was settled.

The contentions set forth above are not, in our opinion, well founded. ">*1105 No controversy as to the ownership of the proceeds from the sale of petitioner's flour existed. It had increased the selling ">*679 price of its flour to include the processing tax and the increased price had been paid by its customers with full knowledge of the facts. It had not legally obligated itself to repay any portion of the sale price to its vendees, nor was there any equitable obligation upon it to do so. As pointed out in Moundridge Milling Co. v. Cream of Wheat Corporation, 105 Fed.(2d) 366, the sales contracts fixed a "composite price" and did not designate the product sold and the tax separately or provide for the refund of any portions of the payments made on past deliveries. Cf. Johnson v. Igleheart Brothers, Inc., 95 Fed.(2d) 4; certiorari denied, 304 U.S. 585">304 U.S. 585. If petitioner were able to save on any of the items going to make up the total cost of the flour which it sold, it thereby increased its profits pro tanto. In our opinion the total amount received by petitioner from the sale of its flour constituted gross income to it. ">*1106 North American Oil Consolidated v. Burnet,286 U.S. 417">286 U.S. 417.

Petitioner next contends that it agreed to settle or compromise its vendees' claims for reimbursement in the year of shipment and that therefore, under a ruling of the Department, ¹ it is entitled to treat the reimbursements as deductions from gross income for that year. The substance of the ruling is that processors, keeping their accounts and filing their returns on the accrual basis, may deduct from gross income "for the year in which they agreed with the vendees to settle or compromise the disputed claims", the amounts so agreed upon. Petitioner argues that it "acknowledged its liability in 1935 and has maintained a consistent position throughout." It relies chiefly upon the statements made by its officers to its customers to the effect that they would be treated fairly and as liberally as customers of other mills were treated, which, it says, constituted an agreement ultimately carried out. We do not agree with this contention. The so-called "treat fairly" agreements were no more than assurances given by petitioner to its customers to retain their good will. The testimony of petitioner's officers">*1107 indicates that they did not intend to bind petitioner to make any repayments to its vendees. Petitioner's counsel and auditor had advised that "it was unsafe to make any definite promises as to amounts that might be paid to the flour buyer." The officers recognizedindeed deliberately chose to bind petitioner no further - that whether any amounts were ever paid to its vendees "would depend upon some other agreement later made." The later agreements, rather than the "treat fairly" promises, were, in our opinion, the bases upon which the payments aggregating $45,865.90 were made.

Having held, as we do that the $45,865.90 must be included in computing petitioner's gross income for the year 1935 and having also held that the payments to its vendees, aggregating that amount, were not ">*680 made pursuant to a specific obligation incurred during the year 1935, we pass to petitioner's contention that the respondent erred "in failing to give due and proper effect to the requirements of sections 41, 42 and 43 of the Revenue Act of 1934 which require the Commissioner to consider credits and deductions for the taxable year in which">*1108 'paid or accrued' or 'paid and incurred', dependent upon the method of accounting upon the basis of which the net income is computed and in so disregarding the mandatory provisions of said sections 41, 42 and 43 as to distort and improperly reflect petitioner's income for said period * * *." ²

The sections relied upon are shown in the margin. ³

">*1109 The identical question was before us in Cannon Valley Milling Co.,44 B.T.A. 763">44 B.T.A. 763, (on appeal C.C.A., 8th Cir.). The petitioner in that case, though under no enforceable obligation in 1935 to pay over to its vendees any of the amount refunded to it in 1936, nevertheless in 1937 paid over a substantial portion of it to them in order to avoid threatened litigation, to keep their good will, and to compromise their claims. We pointed out that the amounts so paid were ordinary and necessary expenses of carrying on a trade or business, citing Superheater Co.,12 B.T.A. 5">12 B.T.A. 5; affd., 38 Fed.(2d) 69; O'Day Investment Co.,13 B.T.A. 1230">13 B.T.A. 1230; H. M. Howard,22 B.T.A. 375">22 B.T.A. 375; International Shoe Co.,38 B.T.A. 81">38 B.T.A. 81, 38 B.T.A. 81">95; Helvering v. Hampton, 79 Fed.(2d) 358; and Welch v. Helvering,290 U.S. 111">290 U.S. 111, and that they were so considered by the Treasury Department; ⁴ held that section 43 was not ">*681 meaningless and should be applied in proper cases; expressed the opinion that the Department could not, by regulation, limit the scope of the section; and concluded that">*1110 the payments made to the vendees should be allowed as a deduction in computing the taxpayer's income for 1935, since they related to the sales made in that year and did not relate to the sales made in the later period. There is no substantial difference between the facts in the instant proceeding and those in the cited case. The $45,865.90 paid by this petitioner to its vendees represented payments under claims relating to sales made in 1935. If such sales had not been made there would have been no basis for the claims and no reimbursements would have been made. On the authority of the cited case and for the reasons stated therein, we hold that the $45,865.90 in issue here should be allowed as a deduction in computing petitioner's income tax for the year 1935. 4

The remaining issue arises in connection with respondent's claim that $2,649.25 should be added to petitioner's gross income for the year 1935. His contention is that petitioner, in 1939, was allowed a refund of processing taxes in the total principal amount of $15,928.85, of which $2,649.25 pertained to the taxable year 1935. The stipulated facts have been">*1111 shown in our findings. They are not entirely clear unless reference is made to some of the figures shown in detail in the exhibits.

During the period the processing tax was being collected (1933 to 1935, inclusive) petitioner deducted from its gross income processing taxes aggregating $318,783.78; $89,151.77 was deducted in 1933, $176,761.05 in 1934, and $52,870.96 in 1935. In the computation attached to the closing agreement the Title VII refund was determined to be $15,928.82 and interest was added in the amount of $4,546.06, making a total of $20,474.88. Petitioner's tax liability under Title III, tax on unjust enrichment, was determined to be $36,880.21. The difference between the latter amount and $20,474.88 or $16,405.33 was paid by petitioner in conformity with the closing agreement. The portion of the "refund" allocable to 1935 was determined by taking 5287096/31878378 of $15,928.82.

Petitioner contends that the closing agreement was a compromise settlement of its Title III and Title VII controversies upon an aggregate, net basis and that no item in the accompanying schedule can be segregated and held to be a "refund" for the year 1935. It argues that the schedules">*1112 became submerged into and were superseded by the written agreement; that it is the only competent evidence of the transaction; that it shows merely a payment of an additional amount of tax ($16,405.33) by petitioner; that no amount was ever "refunded" to it; and that even if a "refund" were actually made, it can not be allocated to the various years. We do not believe that any ">*682 of these contentions are sound. All of the documents should be considered together. Collectively they show that petitioner was allowed a refund of $20,474.88, which, together with payment of $16,405.33, settled its tax on unjust enrichment under Title III. We think, therefore, that the only question to be considered is whether the refund in 1939 of the amount paid in 1935 as an unconstitutional tax should be determined to be income in the year of receipt, or restored to income for the year in which the deduction was taken.

The question was recently discussed at length by this Board in E. B. Elliott Co.,45 B.T.A. 82">45 B.T.A. 82, the majority holding "that all refunds of paid taxes are to be adjusted to the years in which the taxes were paid and deductions claimed, as the best method to">*1113 reflect income; the only proper departure from the rule of adjustment of the refund in the years of payment is where the statute of limitations or some other consideration has made it impossible. In such cases it is obviously inequitable to allow the taxpayer the unjust enrichment which would result and the refund must then be treated as income in the year of receipt." This is determinative of the present controversy. It may be added that, in view of the conclusion reached upon the first issue, it would be highly inequitable to the fiscus to deny the claimed adjustment. On the authority of the cited case this issue is resolved in favor of the respondent.

Reviewed by the Board.

Decision will be entered under Rule 50.

SMITH, KERN, and OPPER concur in the result on the authority of E. B. Elliott Co.,45 B.T.A. 82">45 B.T.A. 82, as to both points.

STERNHAGEN, VAN FOSSAN, MURDOCK, AND TYSON dissent.

ARNOLD

ARNOLD, dissenting: It seems to me that the majority stresses the exception contained in section 43 and ignores the general rule thereof regarding the taking of deductions. The general rule stated in that section, and repeatedly emphasized by the courts">*1114 and this Board, is that "deductions * * * shall be taken for the taxable year in which 'paid or accrued' or 'paid or incurred,' dependent upon the method of accounting upon the basis of which the net income is computed * * *." Under the general rule the entire amount received from flour sales constituted gross income; with this the majority agrees. Under the general rule no deductions could have been taken in 1935 for liabilities that were not incurred, accrued, or paid until later years; with this the majority agrees. It is my opinion that when the majority reaches this point the issue has been decided and there is no justification for carrying back from 1936, 1937, and 1938 deductions accrued in those years and not paid or accruable in 1935. Petitioner's ">*683 1935 income will be clearly reflected by taking into account all items of income and deductions of that annual accounting period.

The majority opinion states that the identical question was before us in Cannon Valley Milling Co.,44 B.T.A. 763">44 B.T.A. 763 (on appeal C.A.A., 8th Cir.), and on the authority of the cited case and for the reasons stated therein holds that the payments to vendees in 1936, 1937, ">*1115 and 1938 are deductible from 1935 income, although not accruable in that year. The cited case holds that amounts so paid were ordinary and necessary expenses of carrying on a trade or business; that section 43 was not meaningless and should be applied in proper cases; and that respondent could not by regulation limit the scope of section 43. That opinion further points out that few instances have arisen in which the courts or this Board have had occasion to consider section 43 and that the cases relied on by the parties litigant furnished but slight aid in determining the issue. It is important therefore to consider the intent of Congress in its enactment of the exception to the general rule contained in section 43.

The exception, as originally enacted by Congress, first appeared in the Revenue Act of 1921, which provided that losses should be deducted in the year "sustained unless, in order to clearly reflect the income, the loss should, in the opinion of the Commissioner, be accounted for as of a different period." Sec. 234(a)(4).

In the Revenue Act of 1924 Congress extended the exception to all deductions and credits. The exception appears in section 200(d) of">*1116 that act in identically the same language as it appears in section 43 of the Revenue Act of 1934. All intervening revenue acts and those enacted subsequent to the taxable year contain the exception in the same language.

In explaining the change made in the exception by the Revenue Act of 1924, the Committee on Ways and Means said: "The Revenue Act of 1921 * * * authorizes the Commissioner to allow the deduction of losses in a year other than that in which sustained when, in his opinion, it is necessary to clearly reflect the income. The proposed bill extends that theory to all deductions and credits. The necessity for such a provision arises in cases in which a taxpayer pays in one year interest or rental payments or other items for a period of years. If he is forced to deduct the amount in the year in which paid, it may result in a distortion of his income which will cause him to pay either more or less taxes than he properly should." (H.R. 179, 68th Cong., 1st sess., pp. 10, 11.) The report of the Senate Committee on Finance is to the same effect and in identical language (S. Rept. No. 398, 68th Cong. 1st sess., p. 10.)

According to the reports of the Ways and Means Committee">*1117 and the Senate Finance Committee Congress intended, by the exception, ">*684 to make provision for cases in which "a taxpayer pays in one year interest or rental payments or other items for a period of years." The payments made by this petitioner to its vendees were not interest payments in one year for a period of years; the payments were not rental payments made in one year for a period of years; nor were they payments in one year of other items for a period of years. As a matter of fact petitioner paid back in one year (1936, 1937, or 1938) a portion of the price of flour sold in 1935. No payments in one year for a period of years are involved in this proceeding and such payments as were made were not because of any obligation growing out of the sale itself, but primarily for the purpose of retaining the good will and the business of certain selected customers. Since the exception was designed by Congress to prevent the distortion of income which would result from deducting in one year the accumulated deductions of a period of years, I can see no reason to apply the exception to an entirely different situation and under circumstances which violate one of the cardinal rules">*1118 of income tax law, namely, that tax liability shall be determined on the basis of annual accounting periods.

Furthermore, it seems to me that the Commissioner's regulations for administering the exception are entitled to more weight and consideration than the majority has given thereto. By section 212 of the Revenue Act of 1924 and section 41 of the Revenue Acts of 1934 and 1936 Congress delegated to the Commissioner the power to determine whether the method of accounting employed by a taxpayer clearly reflects its income, and "if the method employed does not clearly reflect the income" the statutes provide that "the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income." Since a clear reflection of income requires a determination of the period in which deductions and credits shall be taken, like discretion would seem by implication to be contained in section 43. 3 Paul & Mertens Law of Federal Income Taxation, p. 307.

Respondent's regulations have consistently construed section 43 and its prototypes, as a grant of discretion, in the exercise of which he would allow a deduction as of a different period">*1119 only in exceptional circumstances. Art. 146, Regulations 62; art. 43-1, Regulations 86 and 94; T.D. 3261, I-1 C.B. 148. The regulations have always required a taxpayer to take the deduction in the year "paid or accrued" or "paid or incurred" and to submit with the return a complete statement of facts upon which it relies to take deductions as of a different taxable year. The Commissioner would then determine from such facts whether the taxpayer was entitled to the deduction for the period requested. The requirement in the regulation is in ">*685 my opinion a reasonable one and imposes no hardship upon a taxpayer. The successive reenactment of the statutory provisions without alteration have imparted to the regulations the force and effect of law, Helvering v. Reynolds Tobacco Co.,306 U.S. 110">306 U.S. 110, and unless petitioner has complied with the distinct method provided for in the regulations, it can not avail itself of the exception contained in section 43. Stockes v. United States,19 Fed.Supp. 577, 580.

Assuming that the exception is applicable to the facts here, the record does not show that this petitioner made any effort">*1120 to comply with the distinct method provided in the regulations for availing itself of the exception. In my opinion, the petitioner should have so complied if it expected the benefit of the statute. Even if petitioner had complied with the regulations, it is my opinion that the facts and circumstances here are not such as Congress had in mind when it created the exception to the general rule.

For the foregoing reasons I respectfully dissent from the opinion of the majority.

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Footnotes

• 1. G.C.M. 20134↩, C.B. 1938-1, p. 122.

• 2. Paragraph 4 B, amended and supplemental petition. ↩

• 3. SEC. 41. GENERAL RULE.

  The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer's annual accounting period is other than a fiscal year as defined in section 48 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year. (For use of inventories, see section 22(c).)

  SEC. 42. PERIOD IN WHICH ITEMS OF GROSS INCOME INCLUDED.

  The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under section 41, any such amounts are to be properly accounted for as of a different period. In the case of the death of a taxpayer there shall be included in computing net income for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior period.

  SEC. 43. PERIOD FOR WHICH DEDUCTIONS AND CREDITS TAKEN.

  The deductions and credits provided for in this title shall be taken for the taxable year in which "paid or accrued" or "paid or incurred," dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions or credits should be taken as of a different period. In the case of the death of a taxpayer there shall be allowed as deductions and credits for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly allowable in respect of such period or a prior period. ↩

• 4. G.C.M. 20134↩, C.B. 1938-1, p. 122.