Opinion
Docket No. 26172.
1951-06-19
GULF STATES UTILITIES COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
William M. Rice, Esq., and Claude M. Houchins, Esq., for the petitioner. J. Marvin Kelley, Esq., for the respondent.
William M. Rice, Esq., and Claude M. Houchins, Esq., for the petitioner. J. Marvin Kelley, Esq., for the respondent.
1. During its base period petitioner made 17 monthly payments of $8,000 each in order to operate for a 17-month period under the terms of a new contract rather than under the terms of an old contract with Standard Oil. Petitioner claimed the payments as an abnormal deduction as contemplated by section 711(b)(1)(J), I.R.C. Held, petitioner failed to establish that the abnormality was not a consequence of an increase in its gross income during the base period or a decrease in the amount of some other deduction in its base period and was not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer. Under the rule of section 711(b)(1)(K)(ii) the abnormality is not to be disallowed in computing petitioner's base period net income for the excess profits tax credit.
2. Petitioner incurred an abnormal amount of documentary stamp taxes during the base period year 1939 in connection with the refunding of its long term bonds before maturity at a lower rate of interest. Petitioner claimed the tax as an abnormal deduction as contemplated by section 711(b)(1)(J)(ii), I.R.C. Held, the deduction was abnormal in amount under the provisions of section 711(b)(1)(J)(ii) and petitioner has proved the negatives required by section 711(b)(1)(K)(ii) and the abnormal deduction should be disallowed in computing petitioner's base period net income for the excess profits tax credit.
3. Upon the evidence, held, petitioner was not contesting its Louisiana income tax and respondent erred in computing the amount of petitioner's deduction for State of Louisiana income tax for the years 1944 and 1945.
The taxes in controversy in this proceeding are excess profits taxes for the calendar years 1942, 1943, 1944, and 1945. Petitioner contests the following determination of its tax liability as made by the respondent in the deficiency notice:
+---------------------------------+ ¦Excess Profits Tax Liability ¦ +---------------------------------¦ ¦Year ¦Overassessment¦Deficiency ¦ +------+--------------+-----------¦ ¦1942 ¦$31,734.47 ¦ ¦ +------+--------------+-----------¦ ¦1943 ¦ ¦$95,969.16 ¦ +------+--------------+-----------¦ ¦1944 ¦ ¦121,907.28 ¦ +------+--------------+-----------¦ ¦1945 ¦ ¦124,313.16 ¦ +------+--------------+-----------¦ ¦Totals¦$31,734.47 ¦$342,189.60¦ +---------------------------------+
The issues arise in part from the notice of deficiency of the Commissioner dated September 29, 1949, as provided under section 732, I.R.C., in which respondent wrote:
After careful consideration of your claims for relief (Form 843) under section 711(b)(1)(J) of the Internal Revenue Code, filed for the year 1942, it has been determined that your claims for relief filed on March 4, 1946 and June 14, 1946 should be disallowed and that your claim for relief filed June 23, 1947 should be allowed in part. In accordance with the provisions of sections 272 and 732 of the Internal Revenue Code, notice is hereby given of the deficiencies mentioned, and of the disallowance of the claims for refund asserted in your claims for relief (Form 843), filed on March 4, 1946 and June 14, 1946, and of the disallowance in part of the claim for refund asserted in your claim for relief (Form 843), filed on June 23, 1947.
The Commissioner further states in the deficiency notice as follows:
In the determination of your excess profits tax credit and, more particularly, the average base period net income, deductions for the payments made by you in order to secure the cancellation of a contract and for Federal and State stamp taxes have not been disallowed in the absence of evidence establishing that the abnormality or excess is not a consequence of an increase in your gross income in the base period or a decrease in the amount of some other deduction in the base period and in not a consequence of a change at any time in the type, manner of operation, size, or condition of the business in which you are engaged.
By appropriate assignments of error the following issues are raised:
1. Whether or not certain obligations accrued and paid to Standard Oil Company by the petitioner pursuant to the terms of a contract dated September 15, 1937, amounting in the aggregate to $8,000 for the year 1938, and $96,000 for the year 1939 should be disallowed in the computation of petitioner's base period net income under the provisions of section 711(b)(1)(J)(i), I.R.C.
2. Whether or not United States and State of Texas documentary stamp taxes amounting to $23,582.84 and paid in 1939 by petitioner in connection with refunding its long term debt should be disallowed in the computation of petitioner's base period net income under the provisions of section 711(b)(1)(J)(ii), I.R.C.
3. What amounts of Louisiana state income tax are to be accrued and allowed petitioner as a deduction in computing its Federal income and excess profits taxes for the taxable years 1944 and 1945. In support of this issue the petition states, among other things, as follows:
(2) That in the determination of petitioner's adjusted excess profits net income for each of the years 1944 and 1945, the correct amount of State of Louisiana income tax accruable should be deducted, the amount thereof to be computed on a basis including
(a) amortization of emergency facilities over a period of sixty months beginning, in the case of each such emergency facility, with the month following that in which it was completed, and
(b) a proper portion of petitioner's Federal income and excess profits taxes for each such year, as the said Federal taxes may be determined in this proceeding
and producing deductions exceeding those allowed by the Commissioner in his 90-day letter by $40.002.49 for the taxable year 1944 and $25,668.03 for the taxable year 1945.
FINDINGS OF FACT.
Most of the facts have been stipulated and are adopted as our findings of fact. We state below such of these facts as we deem necessary to an understanding of the issues to be decided.
Petitioner is a corporation organized in 1925 under the laws of Texas with its principal office at Beaumont, Texas. Petitioner is a public utility engaged in the business of furnishing steam, electricity, gas, ice, and water.
For each calendar year petitioner filed its tax returns on the accrual basis with the collector of internal revenue for the first district of Texas. Petitioner elected to compute its excess profits tax credit based on its income in base years under the provisions of sections 711-713, I.R.C.
Issue 1— Payments to Standard Oil Company of Louisiana.
In August 1938, petitioner took over all the assets and assumed all the liabilities of its wholly-owned subsidiary, Louisiana Steam Generating Corporation (a Louisiana corporation formerly named Louisiana Steam Products, Inc.), and caused this subsidiary to be dissolved. Among the assets thus acquired by petitioner were: two contracts, one dated October 15, 1929 (hereinafter called the Old Contract), and another dated September 15, 1937 (hereinafter called the New Contract), covering the sale of steam and electric energy required by Standard Oil of Louisiana in the operation of its Baton Rouge refinery; certain contracts covering the purchase of natural gas from Interstate Natural Gas Company; and a contract covering the sale of steam and electric energy required by Ethyl Gasoline Corporation in the operation of its chemical plant. In the liquidation of its subsidiary, petitioner also acquired a plant at Baton Rouge, Louisiana, which was of a special type primarily designed to supply steam and electric energy required in the operation of Standard Oil's refinery and to use by-products of Standard Oil's refinery. The retention of Standard Oil as a customer was essential to the operation of the aforesaid plant without prohibitive loss.
Regular deliveries of steam were commenced under the Old Contract on May 1, 1930. By its terms, the Old Contract was to continue at least until May 1, 1940, and thereafter unless and until one of the parties gave the other 2 years' written notice of cancellation and termination. As originally executed, the Old Contract provided that the quantity of steam required to be delivered to Standard Oil could not exceed 840,000 pounds of steam in any one hour. By an amendment to the contract dated December 29, 1936, the maximum hourly demand was reduced by such amounts of steam as might need be appropriated to fulfill requirements of Ethyl Gasoline Corporation and as did not exceed 70,000 pounds per hour.
Early in 1937, Standard Oil indicated that it was contemplating an increase in its facilities, that its requirements of steam and electricity would be increased and that it was considering the construction of facilities to generate its own steam and electricity. Under the terms of the existing contract Standard Oil, or the petitioner, was required to give written notice by May 1, 1938, if either desired not to continue the Old Contract beyond May 1, 1940. No such notice was given by either party to the contract.
As a result of negotiations the New Contract was executed on September 29, 1937. The New Contract provided that its terms should begin December 1, 1938 (with certain provisos) and terminate on May 1, 1950. Article III of the New Contract provided:
Termination of Present Contract
It is understood and agreed that the existing contract between Generating Corporation and Oil Company dated October 15, 1929, as amended and modified by the contract dated December 29, 1936, shall remain in full force and effect until December 1, 1938, and thereafter until Generating Corporation can supply Oil Company's requirements for steam and electric energy under this contract and has so notified Oil Company in writing. As a consideration for the cancellation of the contract of October 15, 1929, as amended by the contract dated December 29, 1936, on December 1, 1939, or thereafter, as above provided, Generating Corporation agrees to pay Oil Company the sum of $8,000.00 per month for each and every month, and pro rata for any fractional part thereof, after this contract goes into effect, until May 1, 1940.
There was a further proviso that in the event the beginning date of the New Contract was deferred beyond April 1, 1939, on each and every day that full quantities of steam and electricity were not supplied, Standard Oil would be entitled to receive $500 as liquidated damages.
The New Contract was conditioned upon petitioner securing a new contract with Interstate Natural Gas Company for petitioner's supply of natural gas. This condition was fulfilled. Thereupon, petitioner had the right to elect whether it would terminate the Old Contract and put the New Contract in effect on December 1, 1938, or whether it would defer the beginning date and continue to operate under the Old Contract. Until this election was exercised, petitioner was not obligated to pay Standard Oil any monetary consideration for the termination of the Old Contract. Deferment of the beginning date of the New Contract and the termination of the Old Contract until April 1, 1939, might have been accomplished without cost, but a continuation under the Old Contract after that date would have subjected petitioner to the risk of paying daily $500 liquidated damages. In November 1939, petitioner elected to put the New Contract into effect. This election was a voluntary action of petitioner and was made only after due consideration to its effects on petitioner's business.
Petitioner's plant served customers other than Standard Oil. The rated capacity of petitioner's plant at Baton Rouge during the period of the Old Contract was 1,800,000 pounds of steam and 45,000 kilowatts of electric energy each hour. Petitioner planned an expansion of its plant to serve the needs of Standard Oil, Ethyl, Solvay Process Company, and its other customers. Additional steam facilities having a rated capacity of 500,000 pounds of steam per hour were available by December 1, 1938, but on that date the installation of additional facilities for production of electric energy had not been completed. Upon the completion of the new facilities at the plant, the new capacity was 2,800,000 pounds of steam and 95,000 kilowatts of electric energy each hour. Under the Old Contract, as amended, petitioner was to supply Standard Oil with as much as 77,000 pounds of steam per hour and up to a maximum of 20 kw. hr. per 1,000 pounds of steam concurrently taken during a 12-hour period. Under the New Contract the maximum quantity of steam which Standard Oil was entitled to receive was 975,000 pounds per hour, and a maximum of 23 kw. hr. per 1,000 pounds of steam concurrently taken during a 12-hour period. As petitioner could secure electricity from other sources to meet the maximum demands of Standard Oil under the New Contract, petitioner felt that the demands of the New Contract could be met. Petitioner, therefore, elected to come under the terms of the New Contract and thereby obligated itself to make monthly payments of $8,000 to Standard Oil in accordance with Article III of the New Contract.
Both the Old Contract and the New Contract were quite technical, concise and yet necessarily lengthy. Many of the provisions contained in the Old Contract were changed in the drafting of the New Contract. Under the Old Contract petitioner was obligated to purchase waste fuel from Standard Oil's refinery up to but not in excess of 50 per cent of the total heat value of all fuels burned by petitioner during any month. Petitioner was to pay for the waste fuel as follows: 10 cents per million B.T.U. for sludge and 13 cents per million B.T.U. for petroleum coke. For its other fuel petitioner had a contract to purchase at the cost of 15 cents per 1,000 cubic feet of natural gas (975 B.T.U. per 1,000 cubic feet of gas). Under the New Contract petitioner was to be supplied with waste fuels by Standard Oil without cost at the rate of 1,600,000 B.T.U. for each 1,000 pounds of steam delivered under the contract. Under the Old Contract Standard Oil was required to pay: (1) a $5,000 per month demand charge, (2) for minimum daily average for steam at 23 cents per 1,000 pounds, and (3) 2 mills per kw. hr. for electric energy (with 6 mills charged for any excess of electric energy). Under the New Contract Standard Oil was required to pay: (1) a monthly demand charge varying from $10,000 to $14,750 depending upon maximum steam demands, (2) a steam quantity service charge of 2 cents per 1,000 pounds of steam, and (3) for electric energy at rates of 2, 3 1/2, 4, and 6 mills per kw. hr.
In the expansion of its plant at Baton Rouge during 1938 and 1939, petitioner spent approximately $4,209,000; of this sum, $2,977,000 was spent prior to December 1, 1939, and approximately $1,232,000 was spent after that date to complete the facilities which were installed.
On February 23, 1939, petitioner and Ethyl Gasoline Corporation entered into a contract effective December 1, 1938, and continuing to May 1, 1950. The maximum demands of Ethyl stated therein were 270,000 pounds of steam per hour and 25,000 kw. hr. of electricity. Rates for steam were 2 cents per 1,000 pounds, Ethyl to supply also 1,600,000 B.T.U. per 1,000 pounds of steam. Before March 1, 1939, the demand charge for steam was to be not less than $700 per month, and thereafter at least $1,640 per month. Electricity was to be paid for at the rate of 6 mills, 4 mills, and 3 mills per kw. hr. The minimum damage charge was $3,125 where the maximum demand did not exceed 2,500 kw. hr. during any one-half hour during the month.
Pursuant to its election to come under the terms of the New Contract, petitioner became obligated to pay, and did pay, to Standard Oil $8,000 for each month beginning December 1, 1938, and ending May 1, 1940, which payments (amounting in the aggregate to $8,000 for the taxable year 1938, $96,000 for the taxable year 1939, and $32,000 for the taxable year 1940) were claimed and not disallowed as deductions on petitioner's Federal income tax returns. Excepting these payments, at no time in its existence has petitioner paid a consideration for the cancellation of any contract under which it was furnishing a service, nor has it incurred any other obligations of like kind or class.
Petitioner had no deductions in any of the years 1942, 1943, 1944, or 1945 of the same class such as the payments to Standard Oil.
In order to record the monthly obligation of $8,000 at issue, the following bookkeeping entry was made:
+-------------------------------------------------------------------------+ ¦ ¦Dr. ¦Cr. ¦ +-----------------------------------------------------+---------+---------¦ ¦501 OPERATING REVENUES ELECTRIC ¦$8,000.00¦ ¦ +-----------------------------------------------------+---------+---------¦ ¦615.13 ¦ ¦ ¦ +-----------------------------------------------------+---------+---------¦ ¦125.11 ACCOUNTS RECEIVABLE CUSTOMERS (B.R.) ¦ ¦$8,000.00¦ +-----------------------------------------------------+---------+---------¦ ¦Standard Oil Co. of La. a/c 53-1 ¦ ¦ ¦ +-----------------------------------------------------+---------+---------¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------+---------+---------¦ ¦January, 1939 credit to the A. R. C. account of the ¦ ¦ ¦ +-----------------------------------------------------+---------+---------¦ ¦Standard Oil Co. of La. which represents the purchase¦ ¦ ¦ +-----------------------------------------------------+---------+---------¦ ¦price of the unexpired electric and steam service ¦ ¦ ¦ +-----------------------------------------------------+---------+---------¦ ¦contract in accordance with their new contract No. ¦ ¦ ¦ +-----------------------------------------------------+---------+---------¦ ¦K-171 on file. ¦ ¦ ¦ +-------------------------------------------------------------------------+
Petitioner has failed to establish that the obligation to make payments to Standard Oil was not a consequence of an increase in the gross income of the taxpayer in its base period or a decrease in the amount of some other deduction in its base period, and was not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer.
Issue 2— Expenditures for Documentary Stamps.
During the year 1939, petitioner issued $27,300,000 principal amount of First Mortgage and Refunding 30-Year Bonds, Series D, 3 1/2 per cent, due May 1, 1969. The proceeds from the issue of these securities were used to redeem a like principal amount of First Mortgage and Refunding 30-Year Bonds, Series C, 4 per cent, due October 1, 1966. Upon the issue of securities, petitioner incurred and paid United States documentary stamp taxes for the year 1939 in the amount of $27,300 and also incurred and paid State of Texas documentary stamp taxes for the year 1939 in the amount of $9,272.60. The taxes noted above were claimed and allowed as deductions in the computation of petitioner's 1939 Federal income and excess profits tax liability. During the four taxable years preceding the year 1939, similar Federal and State of Texas documentary stamp tax liabilities were incurred and paid by petitioner in respect of the issuance and sale of its debt securities and/or stock. The amount of the aforesaid United States and State of Texas documentary stamp taxes for the year 1939 was in excess of 125 per cent of the average amount of such documentary stamp taxes paid or incurred for the four preceding taxable years by an amount of $23,582.84, but the amount of such documentary stamp taxes was not in excess of 125 per cent of the aggregate of all types of taxes paid or incurred for the four preceding years.
Petitioner did not incur or pay any documentary stamp taxes of the above character for the years 1942, 1943, 1944, or 1945.
Petitioner's expenditures for the aforesaid documentary stamps and the subsequent deductions of the amounts thereof on its tax returns were not the consequence of an increase in the gross income of petitioner in its base period or a decrease in the amount of some other deduction in its base period, and were not the consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by petitioner.
Issue 3— Income Tax Payments to State of Louisiana and to Federal Government.
During the years 1944 and 1945, petitioner was required to pay income taxes to the State of Louisiana. The income tax law of the State of Louisiana applicable for the years 1943 to 1945 (Louisiana General Statutes, annotated 1939, Vol. 6, section 8587.9(1)) provides that among deductions from gross income there shall be: ‘A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.‘ The income tax law of Louisiana, applicable to years 1944 and 1945 (Louisiana General Statutes, annotated 1939, Vol. 6, section 8587.9(c)) allows a deduction from gross income for Federal income and excess profits taxes.
In preparing its 1943 and 1944 Louisiana income tax returns and in accruing the amount of Louisiana income tax for Federal income tax purposes, petitioner amortized its emergency or defense facilities over a period of 60 months, beginning with the month following that in which the facilities were completed or acquired. In preparing its 1945 Louisiana income tax return, petitioner amortized its emergency or defense facilities over a period of less than 60 months, petitioner using the same period for amortization as for its Federal income tax return, the period beginning, in the case of each facility, with the month following that in which the facility was completed and ending as of the termination date of the emergency period (September 30, 1945). It has been stipulated that the amortization deduction under each method would be:
+------------------------------------+ ¦Year¦60-month basis¦Shortened period¦ +----+--------------+----------------¦ ¦1944¦$537,674.29 ¦$1,515,689.22 ¦ +----+--------------+----------------¦ ¦1945¦552,374.66 ¦1,183,365.46 ¦ +------------------------------------+
The Department of Revenue for the State of Louisiana originally ruled that ‘the cost of defense facilities * * * may be depreciated for income tax purposes on the same basis allowed by the Federal Government, wherever the conditions and facts existing justify such an allowance as 'reasonable’ within the terms of the Louisiana statute.‘ Petitioner filed with the State of Louisiana claims for refunds for the years 1943 and 1944 based upon the allegation that amortization of emergency or defense facilities should be computed over the shorter period ending on September 30, 1945. By letter from the Department of Revenue of the State of Louisiana dated July 6, 1948, petitioner was informed that its claim for refund for 1943 Louisiana income tax had been rejected because the legal division of the Department of Revenue had ruled there was no basis under Louisiana income tax law or regulations permitting the amortization of emergency facilities on a ‘collapsed basis.‘ Though no formal action has been taken with respect to the years 1944 and 1945, those years remain open under waivers for proper adjustment and petitioner has been informed, and may expect, the same principle to be applied to the later years. Petitioner has not contested the correctness of the principle and does not intend to do so.
The Department of Revenue of the State of Louisiana holds that under the foregoing section of law, the amounts of Federal income and excess profits taxes which are accruable and deductible for Louisiana income tax purposes are the correct amounts of such Federal taxes as the same may be finally determined. In determining the amounts of petitioner's State of Louisiana income tax accruable and deductible in 1944 and 1945 for Federal income tax purposes, the Commissioner has deducted from income allocable to Louisiana an aliquot part of (a) petitioner's amortization of emergency facilities computed over the shortened period of less than 60 months which was fixed by Presidential Proclamation and (b) an aliquot part of petitioner's liability for Federal income and excess profits tax as determined by the Commissioner and set forth in his 90-day letter dated September 29, 1949.
The parties to this cause are in agreement concerning all factors involved in the accrual of Louisiana income taxes for 1944 and 1945, except with respect to the treatment of amortization of emergency facilities and Federal taxes involved herein. Any error found in the petitioner's Federal excess profits tax liability may be adjusted and the correct deduction for Louisiana income taxes in 1944 and 1945 can be computed under Rule 50.
Any part of the stipulation not specifically set forth herein is incorporated by reference and made a part of these findings of fact.
OPINION.
BLACK, Judge:
The three issues presented for our decision have been set forth in our preliminary statement. The first issue concerns expenses of petitioner incurred during 1938 and 1939, while the second issue concerns expenses of petitioner incurred during the year 1939. The taxable years involved are 1942, 1943, 1944, and 1945. Although the Commissioner determined an overassessment in petitioner's excess profits tax for 1942, we have jurisdiction over that year because petitioner filed claim for relief for that year (Form 843) under section 711(b)(1)(J) of the Internal Revenue Code. The Commissioner has denied petitioner's claim for relief in part and section 732(a), Internal Revenue Code, gives us jurisdiction of a timely appeal from such action of the Commissioner. The years 1938 and 1939 are before us as petitioner seeks relief under section 711(b)(1)(K) of the Code. For the taxable years petitioner elected to compute its excess profits credit upon its base period net income, the years 1938 and 1939 being included in petitioner's base period. Petitioner contends that during the base period years it had two abnormal deductions satisfying the requirements of the applicable Code provisions, and hence should be disallowed as deductions in the computation of its base period net income. The disallowance would, in effect, increase petitioner's base period net income for the purpose of computing its excess profits tax credit, thereby increasing the credit for computing its excess profits tax and reducing petitioner's excess profits tax liability. The third issue involves a determination of the amount of Louisiana income taxes to be accrued and allowed as a deduction by petitioner. This latter issue does not involve any question of abnormality in the base period years.
1. Section 711(b) was added to the Internal Revenue Code as a relief provision for corporate taxpayers who computed their excess profits tax credit based on income and who paid or incurred abnormal deductions during their base period years. Green Bay Lumber Co., 3 T.C. 824. Petitioner seeks relief under the provisions of section 711(b)(1)(J) and (K) which are set forth in the margin.
SEC. 711. EXCESS PROFITS NET INCOME.(b) TAXABLE YEARS IN BASE PERIOD.—(1) GENERAL RULE AND ADJUSTMENTS.— The excess profits net income for any taxable year subject to the revenue act of 1936 shall be the normal-tax net income, as defined in section 13(a) of such Act; and for any other taxable year beginning after December 31, 1937, and before January 1, 1940, shall be the special-class net income, as defined in section 14(a) of the applicable revenue law. In either case the following adjustments shall be made (for additional adjustments in case of certain reorganizations, see section 742(e)):(J) Abnormal deductions.— Under regulations prescribed by the Commissioner, with the approval of the Secretary, for the determination, for the purposes of this subparagraph, of the classification of deductions—(i) Deductions of any class shall not be allowed if deductions of such class were abnormal for the taxpayer, and(ii) If the class of deductions was normal for the taxpayer, but the deductions of such class were in excess of 125 per centum of the average amount of deductions of such class for the four previous taxable years, they shall be disallowed in an amount equal to such excess.(K) Rules for application of subparagraphs (H), (I), and (J).— For the purposes of subparagraphs (H), (I), and (J)—(i) If the taxpayer was not in existence for four previous taxable years, then such average amount specified in such subparagraphs shall be determined for the previous taxable years it was in existence and the succeeding taxable years which begin before the beginning of the taxpayer's second taxable year under this subchapter. If the number of such succeeding years is greater than the number necessary to obtain an aggregate of four taxable years there shall be omitted so many of such succeeding years, beginning with the last, as are necessary to reduce the aggregate to four.(ii) Deductions shall not be disallowed under such subparagraphs unless the taxpayer establishes that the abnormality or excess is not a consequence of an increase in the gross income of the taxpayer in its base period or a decrease in the amount of some other deduction in its base period, and is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer.(iii) The amount of deductions of any class to be disallowed under such subparagraphs with respect to any taxable year shall not exceed the amount by which the deductions of such class for such taxable year exceed the deductions of such class for the taxable year for which the tax under this subchapter is being computed.
In order for a taxpayer to be entitled to have abnormal deductions disallowed in the computation of its base period net income, each requirement of the appropriate sections of the Internal Revenue Code must be satisfied. In the event taxpayer fails to satisfy any one of the provisions of the Code, his contentions for relief must fail. The taxpayer must establish not only that the claimed expenses were abnormal but also that they were not a consequence of any of the limiting factors of section 711(b)(1)(K). As to the first issue, since petitioner, in our opinion, failed to establish that its obligation to make $8,000 monthly payments to Standard Oil, the abnormality ‘is not a consequence of an increase in the gross income of the taxpayer in its base period or a decrease in the amount of some other deduction in its base period, and is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer, ‘ (see section 711(b)(1)(K)(ii)) we need not consider the other statutory requirements which, as contended by respondent, were not satisfied by the petitioner.
How is the petitioner to establish this negative? A similar situation was presented in William Leveen Corporation, 3 T.C. 593, where we said:
To establish such a negative may be a difficult task, and how it is to be accomplished cannot be formulated in a rule. Perhaps the proof is best made by proving affirmatively that the abnormal deduction is a consequence of something other than the increase in gross income and that such proven cause is the converse or opposite of an increase in gross income and could not be identified with an increase in gross income. But difficult as the proof of the negative may be, it is what the statute requires; and, since it is required in clear and express terms, its rigors may not be abated by softening construction.
The findings of fact have set forth the situation of petitioner's business in 1938. Petitioner was expanding its plant facilities to care for the needs of Standard Oil, Ethyl, its domestic and other consumers. After September 15, 1937, petitioner had two contracts with Standard Oil which we have designated as the Old Contract and the New Contract. There was no fixed date on which the New Contract was to replace the Old Contract. Under the terms of the Old Contract, it was to continue indefinitely, unless one of the parties thereto gave written notice to the other, with the earliest date for termination of the Old Contract being May 1, 1940. Under the provisions of the New Contract, however, petitioner could elect to terminate the Old Contract at an earlier date, any date between December 1, 1938 and May 1, 1940. In addition to these two significant dates, the New Contract provided that after April 1, 1939, petitioner would be liable for $500 daily penalty unless steam and electricity were delivered in the increased quantities provided for in the New Contract, even though still operating under the terms of the Old Contract. Petitioner elected to commence the selling of steam and electricity to Standard Oil under the terms of the New Contract at the earliest possible date, December 1, 1938, and thereby became liable to Standard Oil for payment of $8,000 monthly until May 1, 1940.
What would have been the effect on petitioner's net profit if it had elected to come under the terms of the New Contract effective April 1, 1939? What would have been the effect on petitioner's income and deductions had the effective date for coming under the terms of the New Contract been delayed until May 1, 1940? One consequence to petitioner from the exercise of its election was obvious, its net income was reduced at the rate of $8,000 per month by the payments to Standard Oil. If this were the only consequence, why did petitioner exercise its option to come under the terms of the New Contract at the earliest possible date? Were there not other consequences of its election to come under the terms of the New Contract upon petitioner's gross income or deductions, or in the type, manner of operation, size, or condition of the business engaged in by the taxpayer? Petitioner submitted evidence relating to the consequences of its election to come under the terms of the New Contract, as follows: (1) the two contracts; (2) testimony of petitioner's manager of its Louisiana properties; (3) a schedule of receipts from Standard Oil, its receipts in full and its deductions; and (4) a schedule of electricity and maximum steam demands of Standard Oil.
An examination of the contracts reveals differences in that the New Contract provides for: (1) larger demand charges to be paid by Standard Oil, (2) the maximum demand for steam to be increased, (3) a decrease in the service charge per 1,000 pounds of steam, (4) fuel was to be supplied by Standard Oil without charge, (5) a change in the service charge per kilowatt hour of electricity, and (6) a change in ratio of electric service per 1,000 pounds of steam from 20 kw. hr. to 23 kw. hr. The New Contract also contains other detailed provisions providing for contingencies not considered in the Old Contract. In determining the consequences of petitioner's election to operate under the terms of the New Contract as of December 1, 1938, many variables must therefore be considered.
Petitioner has also introduced in evidence two exhibits showing (1) maximum steam demands actually supplied in a single hour during each month from January 1936 to May 1940 and maximum electric demands actually supplied in kilowatts each month from January 1936 to May 1940, and (2) annual sales in dollars of steam and annual sales in dollars of electricity to Standard Oil from 1930 through 1942, including petitioner's profit and loss summary statements for those years.
Leonard, who managed the Louisiana properties of petitioner, was asked by petitioner's counsel:
* * * Why did you terminate the old contract on December 1, 1938, and incur that expense?
He replied:
I terminated the old contract effective December 1, 1938, and by doing so, I obligated the company to pay the cancellation charge of $8,000 per month. I did that, terminated the contract in order to get it out of the way. Once it was disposed of and out of the way, we were enabled to operate under the new contract; and, in my opinion, the company did operate more advantageously than we expected it would under the new contract.
The reply of Leonard to this question was that it was advantageous to the petitioner to come under the terms of the New Contract. But why was it advantageous? Does he mean it was more profitable to petitioner to operate under the terms of the New Contract? Leonard further testified:
The earliest that we could make the new agreement effective was as of December 1938.
Consequently, we wouldn't conceivably have made a decision until immediately prior to that time, when we had made a canvass of the situation and would have known about lots of things.
Petitioner's election was exercised only after a careful consideration of the consequences to petitioner's business.
The two exhibits, even when considered with the testimony of Leonard and the differences in the contracts, fail to support a finding that the petitioner established that the monthly expense of $8,000 incurred by petitioner was not, to use the language of section 711(b)(1)(K)(ii),
* * * a consequence of an increase in the gross income of the taxpayer in its base period or a decrease in the amount of some other deduction in its base period, and is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer.
Section 711(b)(1)(K)(ii) is explicit, saying that ‘unless the taxpayer establishes,‘ and petitioner, in our opinion, has failed to satisfy this provision of the Code.
As to the first issue, we hold that the deduction for payments to Standard Oil is not to be disallowed in the computation of petitioner's net income during the 1938 and 1939 base years under section 711(b)(1)(J), I.R.C., as petitioner failed to satisfy the rule of section 711(b)(1)(K)(ii), I.R.C.
2. The second issue related to a deduction claimed by petitioner in 1939. Documentary stamp taxes amounting to $36,572.60 were incurred by petitioner in connection with the refunding of its funded debt. Petitioner contends the deduction is abnormal as to amount and should be disallowed in the computation of its base period net income, relying on section 711(b)(1)(J)(ii). It has been stipulated that as computed under the rule of section 711(b)(1)(J)(ii) the amount of United States and State of Texas documentary stamp taxes for the year 1939 was in excess of 125 per cent of the average amount of documentary stamp taxes incurred and paid for the four preceding taxable years by an amount of $23,582.84.
The respondent in his brief has relied upon the sole contention that ‘documentary stamp taxes‘ is not a separate class of taxes, but must be grouped with all taxes deducted by petitioner under section 23(c), I.R.C. Under such a grouping the abnormality, as computed under the rule of section 711(b)(1)(J)(ii), is eliminated. Respondent does not contend that the limitations prescribed by section 711(b)(1)(K)(ii) apply as to this claimed abnormality of $23,582.84, and it is clear they do not apply and we have so determined in our findings of fact. We do not think the Commissioner can be sustained in his contention that petitioner's expenditures for documentary stamps must be grouped with all the rest of its taxes, such as income, franchise, ad valorem property, and other recurring taxes necessarily incident to petitioner's day-by-day operations in determining whether the 125 per centum provisions contained in section 711(b)(1)(J)(ii) apply to petitioner's documentary stamp deductions in 1939.
Decisions of our Tax Court have definitely established that the broad classification ‘taxes‘ may be broken into smaller classes for purposes of section 711(b)(1)(J). Thus, in Wentworth Manufacturing Co., 6 T.C. 1201, Illinois unemployment tax was treated as a separate class of deduction; in Horton & Converse, 8 T.C. 487, Federal declared value excess-profits tax was considered separately; in Arrow-Hart & Hegeman Electric Co., 7 T.C. 1350, ad valorem property taxes were considered as separate from other taxes, although our Court refused to distinguish between certain special school district levies and other ad valorem levies; in Harris Hardwood Co., 8 T.C. 874, unemployment compensation taxes were considered apart from other taxes; and in Frank H. Fleer Corporation, 10 T.C. 191, manufacturer's excise taxes were considered as a separate class.
Petitioner does not claim that the documentary stamp taxes paid in 1939 were abnormal in class. It only claims that such taxes were abnormal in amount within the meaning of section 711(b)(1)(J)(ii). The only requirement of section 711(b)(1)(J)(ii) is that the deductions ‘of such class were in excess of 125 per centum of the average amount of deductions of such class for the four previous taxable years.‘ The stipulated facts make proof of this requirement and it is believed that petitioner has met its burden of proof with respect to Issue 2. This issue is decided in favor of the petitioner.
3. The third issue relates to the amount of Louisiana state income tax to be accrued and allowed as a deduction in computing petitioner's Federal income and excess profits taxes for the taxable years 1944 and 1945. The petitioner contends that:
The correct amount of Petitioner's State of Louisiana income tax for each of the years 1944 and 1945, which amount was determinable at the close of each such year, should have been computed by including as deductions, (a) an amount covering amortization of emergency or defense facilities over a period of 60 months beginning with the month following that in which the facilities were completed and (b) a proper portion of the correct amount of Federal income and excess profits tax for the year.
As the (b) portion of petitioner's contention quoted above will follow as a matter of course under a recomputation of tax under Rule 50, no issue is presented for our decision. There remains under the (a) portion of petitioner's contentions an issue which becomes the third issue to be determined.
The petitioner has by appropriate assignment of error contested the amount of deduction for State of Louisiana income taxes allowed by respondent in the determination of petitioner's income and excess profits tax liability for the years 1944 and 1945. In determining the amounts of petitioner's State of Louisiana income tax accruable and deductible in 1944 and 1945 for Federal income tax purposes, the Commissioner has deducted from income allocable to Louisiana an aliquot part of petitioner's amortization of emergency facilities computed over the shortened period of less than 60 months which was fixed by Presidential Proclamation. If it is determined that respondent correctly computed petitioner's Louisiana income tax to be accrued and allowed as a deduction, it has been stipulated that the following deductions for amortization of emergency facilities are correct:
+---------------------+ ¦Year ¦Amount ¦ +------+--------------¦ ¦1944 ¦$1,515,689.22 ¦ +------+--------------¦ ¦1945 ¦1,183,365.46 ¦ +---------------------+
Petitioner contends that a larger amount of Louisiana income tax should be accrued and allowed as a deduction on its 1944 and 1945 Federal tax returns for its liability to the State of Louisiana for income tax. If it is determined that the smaller amount of amortization should be deducted in computing petitioner's Louisiana income tax to be accrued, it has been stipulated that the following deductions for amortization of emergency facilities are correct:
+-------------------+ ¦Year ¦Amount ¦ +------+------------¦ ¦1944 ¦$537,674.29 ¦ +------+------------¦ ¦1945 ¦552,374.66 ¦ +-------------------+
A deduction for such taxes as these is allowed under section 23(c) of the Internal Revenue Code. The only question here is the proper amount of tax to be accrued and allowed as a deduction during the taxable years. The respondent determined that the smaller amounts of tax should be deducted without stating his reasons, but apparently respondent relied upon Dixie Pine Products Co. v. Commissioner, 320 U.S. 516. There the taxpayer contested in the Mississippi courts its liability for a state gasoline tax and, at the same time, accrued and claimed as a deduction on its Federal income tax return the amount of the state gasoline tax. The Supreme Court ruled that a deduction for taxes is not to be allowed ‘where the liability is contingent and is contested by the taxpayer.‘
In Burton-Sutton Oil Co., 3 T.C. 1187, we decided two issues that involved the question of the proper year for an accrual basis taxpayer to deduct State of Louisiana income taxes and franchise taxes. Since the taxpayer was contesting its Louisiana income tax liability for the years 1937 and 1938, in reliance on Dixie Pine Products Co. v. Commissioner, supra, we held that the taxpayer was not entitled to deduct during the years 1937 and 1938 the contested additional income tax liability asserted in 1941 against the taxpayer by the Department of Revenue of the State of Louisiana. But as to the other issue, the deficiency in franchise taxes asserted by the Department of Revenue of the State of Louisiana in November 1940, we held the taxpayer was allowed to accrue and deduct the tax deficiency in 1937 and 1938 for the liability for additional taxes was paid and not contested by the taxpayer.
In H. E. Harman Coal Corporation, 16 T.C. 787, the accrual basis taxpayer was notified by the State of Virginia in 1941 of a deficiency in state income taxes for the years 1938 and 1939. The state income tax deficiency was paid in 1941 and claimed as a deduction on its 1941 Federal tax return. As the deficiency in state income tax was not contested, the tax was disallowed as a deduction in 1941.
Is the petitioner contesting its Louisiana income tax liability for the years 1944 and 1945? It has been stipulated: ‘Petitioner has not contested the correctness of the principle (the principle that caused the rejection of the 1943 claim) and does not intend to do so.‘ It was further stipulated that in the year 1944 petitioner computed its Louisiana income tax liability by deducting amortization on a 60-month period and accrued its tax deduction for Federal income and excess profits tax accordingly. For the year 1944 petitioner has filed a claim for refund, but the claim is being denied by the State of Louisiana and petitioner does not plan to litigate the question. It was further stipulated that in the year 1945 petitioner computed its Louisiana income tax and the accrual of state tax as a deduction for Federal income tax purposes by deducting amortization over a period of less than 60 months. We can see no reason why petitioner cannot expect a deficiency to be asserted by the State of Louisiana for the year 1945. Under the rule of H. E. Harman Coal Corporation, supra, petitioner, an accrual basis taxpayer who concededly is not contesting its liability for Louisiana income taxes, would not be allowed a deduction under section 23(c) of the Code, either in the year of payment of the tax deficiency or in the year the tax deficiency was determined. The proper years for the deductions for petitioner must, therefore, be 1944 and 1945. It view of the stipulations, it is determined that petitioner is not contesting the additional Louisiana income tax.
What is the proper amount of Louisiana income tax to be accrued by petitioner? That is to say, is the petitioner's Louisiana income tax liability to be computed by deducting amortization of emergency facilities on a 60-month period, or may petitioner use a shortened period for computing its amortization deduction? This question is one to be determined by the Louisiana income tax laws and can most appropriately and properly be done by their own department of revenue and courts. Fortunately, we need not interpret the law and weigh the merits of the question for rulings on petitioner's claims have been made by the appropriate state department. It has been argued by respondent that the original ruling of the Department of Revenue of Louisiana is contradictory to the position taken by the taxing authority in disallowing petitioner's claim. This may be true, but the denial by the Department of Revenue of Louisiana of petitioner's claim in July 1948 was subsequent to the principle contained in Louisiana Revenue Bulletin, Volume 1, Number 2, issued November 25, 1940. Furthermore, the denial of petitioner's claim is a specific ruling on petitioner's liability for Louisiana income taxes, and we see no reason why it should not dispose of the issue though the revenue bulletin may be to the contrary.
It appears from the facts which have been stipulated that petitioner's Louisiana income tax liability will be determined by allowing to petitioner only the smaller deduction based upon amortization over a 60-month period. Accordingly, petitioner should be allowed to accrue as a deduction in 1944 and 1945 the larger liability for Louisiana income taxes, since the difference in tax is not being contested by petitioner. This issue is decided in favor of the petitioner.
Decision will be entered under Rule 50.