Commercial Electrical Supply Co. v. Commissioner

1927 BTA LEXIS 2748 | B.T.A. | 1927

Lead Opinion

OPINION.

Teammell :

The material facts in these proceedings are undisputed, and the pleadings raise only two issues for decision here, which will be considered in the order presented.

The first issue relates to deductions, under section 234 (a) (1) of the Revenue Act of 1918, of certain bonuses paid by the petitioner to its employees. Petitioner kept its books on the accrual basis, and subsequent to the close of each fiscal year involved, by formal action of the board of directors authorized the payment of a bonus to employees in quarterly installments during the following calendar year. The amount of each bonus thus authorized was accrued on petitioner’s books as of January 31, the last day of the preceding fiscal year, and claimed as a deduction for that year. The bonus authorized was payable only to employees of record at the several times scheduled for payment. The amount of each bonus accrued but not actually paid to its employees was thereafter reported by petitioner as income in its tax return for the subsequent year. Respondent disallowed the deduction claimed by the petitioner of the amount accrued on its books for the year of accrual, but allowed the amounts actually paid to the employees as deductions for the years in which they were authorized and paid. Petitioner contends that it is entitled to a deduction of the amount of each bonus accrued, for the year of accrual. Respondent contends that petitioner incurred no legal obligation to pay the bonuses in question in the respective years in which they were accrued on the books, and that the bonuses were not solely for services actually rendered during the year in which they were accrued.

The Revenue Act of 1918 provides in pertinent part as follows:

Se». 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:

(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered * * *.

It is undisputed that the amounts involved in these proceedings were paid or incurred as compensation for personal services.in carrying on a trade or business, and were reasonable. Were they incurred in the respective taxable years for which they were claimed as deductions by petitioner ?

The principles stated in Appeal of Van De Kamps Holland Dutch Bakers, 2 B. T. A. 1247, are applicable to the instant case. During the respective taxable years in question, no binding agreement was entered into between the petitioner and its employees for the payment of a bonus. The amount of the bonus was not determined nor any definite method fixed by which it could be computed. The only basis disclosed by the evidence to support even a moral obligation was the rather vague promise of the directors that if the business was prosperous the bonus would be a liberal amount. Furthermore, the amount of the bonus allotted to each employee for the preceding fiscal year was payable only in the event such employee remained in the service of petitioner until the several dates scheduled for payment during the succeeding year. Under these circumstances, the promise of the directors did not create an obligation legally enforceable against petitioner, and it could not accrue on its books for the preceding fiscal year a moral obligation of such an indefinite and contingent nature which would thereby justify a deduction of the accrued amount. We must hold, therefore, that petitioner is only en-titléd to deductions of the amounts of the bonuses actually paid to its employees for the respective years in which they were authorized by the board of directors. The bonuses were to be paid with a view to services in 1920 and as an inducement for the employees to remain with the company. The action of respondent in respect of the first issue is affirmed.

The second issue is predicated upon the action of the respondent in adding to petitioner’s income for the fiscal year ended January 31, 1919, the amount of $4,370.37 upon the ground that it had been received by the petitioner in that year as compensation for damages to its business on account of loss of profits. Petitioner purchased merchandise from the General Incandescent Lamp Co. from time to time during 1909 and 1910. At March 31, 1910, the account of the lamp company on petitioner’s books showed a credit balance of $9,118.16. The lamp company thereafter refused to make further sales to petitioner and petitioner refused to pay to the lamp company the balance due it for merchandise, at the same time asserting a counterclaim against the lamp company in excess of said balance. Litigation arose over the matter, which was finally adjusted in May, 1918, under a compromise agreement by which petitioner paid to the lamp company 50 per cent of its account, or the sum of $4,559.08, in full settlement, thus retaining an equal amount as damages for loss of profits. Petitioner paid court costs in the amount of $188.71, leaving a balance of $4,370.37 of which it received the benefit and advantage during the taxable year. Petitioner contends that when its counterclaim arose against the lamp company, the credit balance of $9,118.16 shown on the lamp company’s account, which theretofore had represented a liability, became in effect a reserve for a contingent liability, and that the amount of such reserve should be included in its invested capital. Also that the amount of $4,559.08 paid by it to the lamp company is deductible as a business expense.

An extended discussion of petitioner’s first contention seems to us unnecessary. Its liability to the lamp company was not changed into an asset by the mere assertion of the counterclaim. It very properly continued to carry the lamp company account on its books as a liability from March 31,1910, to May 2, 1918, when the final settlement ■was made. Nor was the lamp company’s account changed into the nature of a reserve for a contingent liability by the assertion of petitioner’s counterclaim. The petitioner did not set up on its books such a reserve. It follows that petitioner is not entitled to include the amount in question in the computation of invested capital.

The second contention of petitioner that the amount paid by it to the lamp company in 1918 represents a deductible business expense must likewise be denied. The net amount of $4,370.37 of which the petitioner received the benefit in the final settlement constituted income to it in the year in which received. William Henry Nolker, president of petitioner, testified at the hearing with reference to this matter as follows:

A. * * * Our counterclaim against the General Incandescent Lamp Go. for losses sustained, that is to say losses in business — our business in lamps dwindled by reason of this supertrust refusing to sell us goods.

Q. Just proceed and describe all of the negotiations.

A. Well, our attorney then took the matter in hand and, as I said before, our counterclaim was far in excess of the amount of money we owed them according to our books and eventually the thing was compromised and we accepted as damages 50 per cent of the amount shown on our books.

The Member. You mean you had a claim against them?

The Witness. Yes, we had a claim against them not only under the Sherman Anti-Trust Act, but also a claim for loss in business — a material claim — that is loss of profits.

The contentions of petitioner with respect to the second issue rest wholly upon the false premise that its counterclaim set up in 1910 wiped out its liability to the lamp company. The fallacy of such contentions is self-evident, since the lamp company declined to recognize the justness of the counterclaim and instituted litigation, which was not finally settled until May, 1918. At that time petitioner discharged its liability of $9,118.16 to the lamp company by the payment of $4,559.08. The difference between the amount paid and the liability discharged, less the expense item of $188.71, or the net amount of $4,370.37, represents the compensation received by petitioner for loss of profits. Accordingly, the action of respondent in adding this amount to petitioner’s income for the fiscal year ended January 31,1919, is approved.

Judgment will he entered for the resfondent.

Considered by Momas, Mukdock, and Siefkin.