1935 BTA LEXIS 967 | B.T.A. | 1935
Lead Opinion
OPINION.
Respondent determined a deficiency of $7,345.21 in petitioner’s 1929 income tax. Petitioner alleges that the determination is erroneous, in that respondent (1) overstated gross profit from trading, and (2) disallowed a deduction of $41,744.63 for salaries incurred within the year.
Petitioner, a Delaware corporation, was organized on June 8, 1925, succeeding to the businesses of two partnerships. At first its principal business was selling pig iron and other metals on a commission basis. In 1929 its commission sales amounted to $3,447,-051.80 and its sales for its own account amounted to $17,254,791.81.
Petitioner keeps its books on an accrual basis.
In its 1929 return petitioner reported gross income from “ commissions earned ” in the sum of $872,548.01, of which $69,449.76 represented commissions earned on sales of pig iron and other metals,
The petitioner asserts that the result of its trading in crude rubber was a loss of $176,360.93 and not a gross profit of $215,727.58, as reported in the return. The reported gross profit was computed by deducting from the total of crude rubber sales ($7,788,415.24) the total actual invoice cost ($7,572,687.66) to petitioner of the crude rubber sold. The petitioner contends that cost should be represented not by actual invoice cost, but by a figure that reflects the sum of the opening inventory at cost or market, whichever is lower ($178,668.77), plus total cost of purchases during the year ($9,685,359.38), less closing inventory at cost or market, whichever is lower ($1,899,251.98), or $7,964,776.17. Taking the latter figure as cost, a loss from crude rubber sales in the amount asserted by the petitioner would be reflected. The parties agree that this $7,964,776.17 is the correct cost of goods sold figure if petitioner is entitled to use inventories valued on the basis of cost or market, whichever is lower, in computing net income. The respondent concedes petitioner’s right to use inventories for that purpose, but contends that a previous election by petitioner, to value inventories on the basis of cost, is binding upon the petitioner for the taxable year. If that be the case, the result of the year’s trading in crude rubber has been correctly reported in the return; for the arithmetical result of a computation of cost, when based upon cost of purchases and inventories valued at cost — there being no evidence of actual loss, through shrinkage, spoilage, or other cause, of otherwise inventoriable crude rubber — would be the same figure as that representing actual invoice cost. Thus the question resolves itself into one of whether petitioner is entitled to value its current inventories of crude rubber on the basis of cost or market, whichever is lower, or is limited to a valuation at cost.
By section 22(c) of the Eevenue Act of 1928 taxpayers are required, whenever in the opinion of the Commissioner inventories are
Section 22(c) provides two tests to which each inventory must conform:
(1) It must conform as nearly as may he to the best accounting practice in the trade or business, and
(2) It must clearly reflect the income.
It follows, therefore, that inventory rules can not be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order to clearly reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used is substantially in accord with these regulations. An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income.
The bases of valuation most commonly used by business concerns and which meet the requirements of section 22(c) are (a) cost and (b) cost or market, whichever is lower. * * *
* * * Taxpayers were given an option to adopt the basis of either (a) cost or (b) cost or market, whichever is lower, for their 1920 inventories. The basis adopted for that year is controlling, and a change can now be made only after permission is secured from the Commissioner. Application for permission to change the basis of valuing inventories shall be made at least 30 days prior to the close of the taxable year for which the change is to be effective. * * *
Also, article 101 of Regulations 74 provides that “ In order to reflect the net income correctly, inventories at the beginning and end of each year are necessary in every case in' which the production, purchase, or sale of merchandise is an income-producing factor.” The foregoing provisions of the 1928 Act and Regulations 74 have their counterpart in section 205 of the Revenue Act of 1926 and articles 1611 and 1612 of Regulations 69, which governed the years 1925 (petitioner’s first taxable year) to 1927, inclusive. By these statutory and regulatory provisions, it was mandatory upon the petitioner to elect an acceptable basis for valuing the inventory of the year in which purchases and sales became income-producing factors, and such election was thereafter binding upon it unless and until it secured the permission of the respondent to change to another basis.
While the stipulated facts and other evidence are not entirely clear about the matter, we gather from those sources that purchases and sales of crude rubber and other commodities have been income-producing factors in petitioner’s business from the beginning of its corporate existence and that inventoriable commodities, though perhaps not in large quantities in the first two years, have been carried
In the 1928 return petitioner, in answer to a specific interrogation about the matter, stated that its opening inventory of $568,-700.48 and its closing inventory of $203,290.93 were valued “At cost or market whichever is lower.” In the 1929 return petitioner answered that its opening (1928 closing) inventory of $203,290.93 and its closing inventory of $2,526,019.69 were valued at “ Cost.” Now it is obvious that both of these statements as to the 1928 closing (1929 opening) inventory cannot be correct; for the inventory valuation could not be the same on both bases, unless cost was lower than market at the close of 1928, and that clearly was not the case, because the parties have agreed that the cost of crude rubber (but not of the other commodities) then on hand was higher than its then market value, and that the value of the 1928 closing (1929 opening) inventory at cost or market, whichever is lower, was $189,635.15. That that inventory was actually valued at cost, and not the lower of cost or market, not only in the 1929 return but in the 1928 return as well, is clear from the following computation:
Invoice cost of goods in 1929 closing inventory as shown in 1929 return-$2, 526, 019. 69
Add: Invoice cost of goods sold in 1929_ 16, 593,442. 07
Total_i_19,119,461. 76
Deduct: Invoice cost of all purchases in 1929_18,916,170. 83
Invoice cost of goods sold in 1929 opening (1928 closing) inventory as shown in the 1928 and 1929 returns-- 203,290.93
In view of the foregoing, we hold that the record does not show an election by the petitioner in 1928, or at any previous time, to value its inventories on the basis of cost or market, whichever is lower, but that, notwithstanding the statement in the 1928 return, it has consistently valued its inventories, at least from and including 1927, at cost.
The petitioner argues, however’, that the best accounting practice in “ the rubber business ” is to use inventories valued at cost or market, whichever is lower; and that income is distorted by the use of inventories otherwise valued, because of daily price fluctuations in the rubber market and the narrow margin of profit in dealings in that commodity. The argument is supported, to some extent, by the opinions of petitioner’s witnesses. But petitioner’s inventories were made up, not only of crude rubber, but of many other commodities — pig iron, mica, shellac, coke, fluorspar, alloys, etc., and so-called “export merchandise.” True, crude rubber was the principal single item in and made up the greatest part of the 1929 inventories, but that commodity represented no such an important part of previous inventories. Whatever the best accounting practice as to inventories in “ the rubber business ” may be, it is no more a criterion of the best accounting practice in a jobbing business dealing in a large group of unrelated commodities than would be the practice in a business dealing exclusively in pig iron, or mica, or fluorspar, or any one of the other commodities which made up petitioner’s gross sales. This is not a case where dealings in each separate commodity constituted a separate business, but rather where the business was made up of several departments, each engaged in dealing in a different commodity.
In general, the business may be likened to departmental merchandising. In a business of that character the inventory method must be uniformly applied throughout all departments and to all commodities or merchandise, irrespective of what the best accounting practice may be in a trade or business of dealing in any one of the separate commodities represented in the inventory. Moreover, it is inconceivable that petitioner’s income is distorted by the use of inven
We would not pass unnoticed petitioner’s argument on the brief that it is not seeking a change in inventory method, because it “ never took physical inventories or used inventories in computing the income shown on the returns filed.” The inference is, of course, that, never having taken or used inventoried to determine income, the cost method of valuing inventories has not heretofore been adopted or used. But the premise is only a half truth born of sheer expediency.
In the first place, a physical count of goods in the 1928 and 1929 inventories must have been available to the petitioner and the respondent, otherwise they would not have been able to agree upon and stipulate, as they have done, the value of the goods in those inventories, at cost or market, whichever is lower. Secondly, while petitioner has not in the taxable year or previously computed cost of goods sold by the formula of “ opening inventory, plus purchase, less closing inventory ”, such a procedure was wholly unnecessary; for, as already pointed out, the arithmetical result of that formula, when the inventories are valued at cost, assuming that there have been no inventory losses through shrinkage, spoilage, or other similar causes, is the same figure as the actual invoice cost of the goods sold, which petitioner used for computing gross profit from sales. That there were no inventory losses is evident from the same reasoning and computations by which we determined that the inventories shown in the 1928 and 1929 returns were valued at cost; for had there been such inventory losses, the computations and reasoning would have yielded entirely different results. The parties have stipulated that: “ The result of the method employed by the petitioner in computing taxable net income on the income tax return filed for the years 1929 and prior years was to disregard all purchases of goods
In view of the foregoing, we hold there is no error in the amount of gross profit from sales of crude rubber reported in the return for the taxable year in question.
The final question for consideration is whether respondent erred in disallowing the deduction of $41,114.63 representing a so-called “ Keserve for additional compensation.” The facts in respect of this matter have all been stipulated and, being brief, we quote that part of the stipulation below:
As a liability under an officers and employees bonus and profit sharing plan based on a percentage of the annual net earnings of the petitioner, an account was accrued and set up on the books of the petitioner during the year 1929 styled “ Reserve for Additional Compensation ” in the sum of $57,000. This represented the estimated amount of additional compensation due under the Bonus Plan. During the year 1929 advances had been made and paid out under the Bonus Plan in the sum of $15,225.37, leaving an estimated balance due as of December 31, 1929 of $41,774.63 for the year 1929. When the final computation of the amount due officers and employees under the Bonus Plan was determined for the year 1929, the so-called Reserve for Additional Compensation was found to be underestimated in the sum of $851.18. In addition to the advances made during the year 1929, payment of the additional compensation for the year 1929 was made under the plan in the total sum of $42,625.81 — $36,532.82 being paid in January, 1930 and $6,092.22 in February, 1930.
The petitioner now claims not only the $41,774.63 disallowed by the respondent, but an additional $85,1.18 representing the amount by which its liability for additional compensation was understated in the return, a total of $42,625.81.
There is no dispute as to the reasonableness of the deduction claimed. The respondent disallowed $41,774.63 of the deduction on the ground that the applicable statute does not provide for the deduction of amounts credited to a “ reserve for salaries.” His position in the matter is further stated on the brief as follows: “ In closing the books for 1929 the petitioner could have accrued as a definite ascertained liability the amount of $57,851.18 as of December
Decision will 5e entered, wider Rule 50.