Opinion
Docket Nos. 13006 13013.
1949-09-29
STANDARD PAVING COMPANY, A DISSOLVED CORPORATION, APPEARING THROUGH I. V. GRAY, CHAS. GRAY, J. L. GRAY, J. B. GRAY and H. C. GRAY, ITS DIRECTORS AT THE TIME OF DISSOLUTION AND ITS LIQUIDATING TRUSTEES, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.STANDARD PAVING COMPANY, A CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Geo. E. H. Goodner, Esq., and Roger S. Randolph, Esq., for the petitioners. E. G. Sievers, Esq., and Allen T. Akin, Esq., for the respondent.
1. Corporation A, on its own behalf and as a member of joint ventures, entered into long term construction contracts. While the contracts were in the course of being completed, it transferred all of its assets to corporation B, its parent, in a nontaxable reorganization. Thereafter the contracts were completed by the transferee. Both corporations reported income from contracts by the completed contract method. Held, that under the circumstances it was proper for the Commissioner to allocate to corporation A, under section 41 of the code, income earned under the contracts based upon the percentage of completion thereof at the time of the reorganization.
2. Corporation A, having been dissolved promptly after the reorganization, is not entitled to deduct from gross income during the last taxable period of its existence any operating loss sustained by corporation B in a subsequent taxable year by reason of an allocation of income from the contracts to the former.
3. Corporation A paid, during the taxable year, additional stated income taxes for a prior year without earlier knowledge of the amount of the additional tax. Held, that the additional state income taxes are not deductible in the taxable year. Geo. E. H. Goodner, Esq., and Roger S. Randolph, Esq., for the petitioners. E. G. Sievers, Esq., and Allen T. Akin, Esq., for the respondent.
These proceedings were consolidated for hearing. The proceeding in Docket No. 13006 involves deficiencies in declared value excess profits tax and excess profits tax for the period January 1 to September 20, 1942, inclusive, in the amounts of $29,734.80 and $197,172.48, respectively. A claim is made that excess profits tax for 1942 was overpaid in the amount of $4,309. Docket No. 13013 involves transferee liability for such taxes and a deficiency of $104.67 in income tax for the calendar year 1941. The issues in Docket No. 13006 are whether petitioner realized income from certain long term construction contracts and whether it is entitled to a deduction in the amount of $488.87 for Oklahoma state income taxes. The only issue before us for decision in Docket No. 13013 is the amount, if any, of tax liability of the transferor for the year 1941 and the taxable period in 1942.
FINDINGS OF FACT.
The petitioners in Docket No. 13006 are the trustees in liquidation of the Standard Paving Co., a dissolved Oklahoma corporation, hereinafter referred to as ‘Oklahoma Standard.‘ Oklahoma Standard was organized in 1921 and thereafter until the close of September 20, 1942, was engaged in construction of roads, streets, bridges, dams, airports, and other public work in the general contracting business.
The petitioner in Docket No. 13013, the Standard Paving Co., hereinafter referred to as ‘Delaware Standard,‘ was organized under the laws of Delaware in 1930 under the name of Standard Bond & Investment Co., which corporate name it operated under until about September 20, 1942, when, in accordance with a plan of reorganization, effective at that time, it was changed to its present name. It was organized for the purpose of financing enterprises, but was practically dormant until September 1942. It owned all of the stock of Oklahoma Standard and the Standard Roofing & Material Co., an Oklahoma corporation engaged in the building material and roofing business, except five qualifying shares in each, which were held by the petitioners in Docket No. 13006, who held all of the stock of Delaware Standard on September 20, 1942.
The corporations kept their books of account and filed their tax returns with the collector for the district of Oklahoma on an accrual basis. Income from construction contracts was reported on the completed contract method, which method was not questioned by the Commissioner prior to the determination of the deficiencies involved herein.
On February 18, 1942, Oklahoma Standard, S. E. Evans Construction Co., and Layman Construction Co., by a written agreement, formed a joint venture, hereinafter referred to as the Gruber Joint Venture, for the purpose of contracting with the Manhattan Construction Co. and the Long Construction Co. to perform, as subcontractors, a certain portion of the construction work at the Cookson Hills Cantonment near Braggs, Oklahoma, hereinafter referred to as the Gruber Project. The coadventurers agreed to close the books of account of the joint venture as soon as possible after the completion of the work and to share profits and losses equally. The Gruber Joint Venture operated under the name of Evans, Gray & Layman. The members of the Gruber Joint Venture entered into the contract on March 2, 1942. The construction contract provided for payment of liquidated damages to the prime contractor in the event of failure of the subcontractor to complete the contract within the time set forth in the prime contract. Payments for work performed were to be made by the prime contractor in accordance with provisions of the prime contract and upon receipt by it of payments from the United States.
On August 15, 1942, the members of the Gruber Joint Venture, as coadventurers, entered into a letter contract with the United States, subject to changes, for the construction of certain access roads near the Gruber Project for the approximate amount of $73,514.70. It was contemplated that the agreement would be supplemented by a formal contract, which formal contract, hereinafter referred to as the Roads Project, was entered into as of August 15, 1942, but an executed copy thereof was not delivered by the United States to the coadventurers until November 7, 1942. Change orders increased the amount of the contract to $96,344.23. Of this amount, $51,952.08 was paid on September 15, 1942, under the first estimate covering the period ended September 10, 1942, and $30,826.80 for the period specified as September 11, 1942, to September 25, 1942, was paid on November 11, 1942. The remainder, including retainage of $9,197.65, was paid on December 8, 1942, pursuant to an estimate showing September 18, 1942, as the actual date of completion of the contract. The contractors were notified by the United States on December 3, 1942, that all work under the contract had been completed on September 18, 1942, in accordance with the plans and specifications, and that final acceptances of the work would be considered as having been made as of September 18, 1942.
On April 7, 1942, Oklahoma Standard entered into a contract, hereinafter referred to as the ‘Memorial Boulevard Contract,‘ with the State Highway Commission of the State of Oklahoma for the construction of certain roads near Tulsa, Oklahoma.
On May 20, 1942, Oklahoma Standard, the Spencer Construction Co., and Lee Harris, acting as joint venturers, entered into a contract with the United States for the construction, as the prime contractor, of an airfield near Dalhart, Texas, hereinafter referred to as the Dalhart Project. Provision was made in the contract for payment of liquidated damages in the event of failure to complete the work within a specified time. The joint venture, hereinafter referred to as the Dalhart Joint Venture, was formed on May 21, 1942, for the purpose of constructing the airfield under the contract and operated under the name of Standard, Spencer & Harris. The joint venture agreement specified the work to be performed by each coadventurer under the contract. The work to be done by the Spencer Construction Co. was to be completed by August 20, 1942; by Lee Harris, by September 5, 1942; and by Oklahoma Standard, by September 20, 1942. Other provisions of the contract read as follows:
It is further agreed by and between the parties hereto that if at any time it shall become necessary in performance of the contract herein mentioned to expend any sums of money in connection therewith, that the party for whose benefit said sums are expended shall pay said sums out of any and all money (sic) shall be entitled to receive for the work herein agreed to be done.
It is further agreed by and between the parties hereto that each of the parties shall provide Public Liability and Workmen's Compensation Insurance as provided by said contract on all the work which he agrees to do and perform herein. That each of the said parties shall pay and all insurance premium which shall accrue on his separate portion of the work to be performed herein. It is further agreed that each of the parties herein named shall pay any and all premiums on all bonds written on their respective portion of the work agreed herein to be done.
It is further agreed by and between the parties that each of the parties herein named assumes for himself the responsibility of performing and completing the work herein agreed to be done.
It is understood by all the parties that ten per cent (10%) of the estimates and sums to be paid on said contract shall be retained as provided in the specifications furnished by the War Department.
The contracts for the Gruber, Dalhart, and Roads projects provided that in making partial payments for work done there would be retained 10 per cent of the estimated amount until final completion of and acceptance of all work covered thereby, hereinafter referred to as ‘retainage,‘ with a provision, however, that at any time after 50 per cent of the work had been completed the United States, if it found that satisfactory progress was being made, might make any remaining partial payments in full. Some partial payments were made under the contract for the Gruber Project without retaining any amount. The contracts also provided that the United States could increase or decrease the amount of work to be performed under the agreements, or terminate them at any time in whole or in part, and, if necessary to complete the work on schedule, require the contractor to work 24 hours a day, 7 days a week; and that delays to scheduled progress of the work caused by unfavorable weather conditions or labor difficulties should be offset by additional plant facilities and labor to complete the work within the prescribed time and in the event the contractor failed to provide such facilities, the United States might do so at the expense of the contractor. The contracts of the Gruber and Dalhart projects contained provisions entitling the contractors to recover the cost of their work in the event the work was damaged by enemy operations and the United States decided not to replace or repair the work.
Oklahoma Standard was liquidated as of the close of September 20, 1942, in a nontaxable reorganization by transfer of all of its assets, subject to its liabilities, to Delaware Standard, in exchange for its stock. The stock of Oklahoma Standard was thereupon canceled. Delaware Standard expressly agreed as part of the reorganization to perform all of the uncompleted contracts of Oklahoma Standard. Pursuant to an application therefor the District Court of Tulsa County, Oklahoma, on November 12, 1942, entered a decree of dissolution of Oklahoma Standard. By reason of the nontaxable reorganization of the corporation, Delaware Standard acquired all the assets and assumed all of the liabilities of Oklahoma Standard at their cost or book value to the latter, and neither corporation realized any taxable gain or sustained any deductible loss in the transaction. After September 20, 1942, Delaware Standard completed all of the incompleted contracts of Oklahoma Standard. Counsel for Oklahoma Standard was requested in about September 1941 to propose a plan of reorganization in which one of the corporations would be eliminated.
The contract of the Gruber Joint Venture for the Gruber Project was incomplete at the close of September 20, 1942. The Gruber Joint Venture received $2,157,893.88 prior to September 21, 1942, as partial payment for work done under the contract. The United States had withheld up to that time the amount of $116,328.43, as retainage, and the amount of $6,300 for liquidated damages under the contract after payment of $49,247.32 of retainage in June 1942.
Thereafter, the joint venture received from the prime contractors, out of payments made under estimates for the two equal periods extending from September 11 to October 10, 1942, and the period from November 26, 1942, to January 10, 1943, the amounts of $100,444.17, $155,451.65, and $7,477.09, respectively. The last payment was received from the proceeds of a check issued by the United States on January 21, 1943, and consisted of an amount for work done, plus retainage of $30,789, less an adjustment in the amount of $44,053.43. No amounts were received by the joint venture out of payments made by the United States under estimates for periods from October 11 to November 25, 1942, except retainage in the net amount of $100,000. The total amount received by the joint venture under the contract was $2,521,016.79. The total cost of the Gruber Joint Venture was $2,229,721.76, of which $1,955,586.55 or 87.7054 per cent was incurred to the close of September 20, 1942. The portion of each amount allocable to Oklahoma Standard was one-third thereof.
After September 20, 1942, the construction contracts of the Gruber Joint Venture were amended five times, including amendments granting extensions of 42 days within which to complete the work, and for increases aggregating $347,185.52 in the contract price. No portion of the $347,185.52 could be paid to the Gruber Joint Venture until the amendments had been executed by the parties thereto.
On May 10, 1943, the United States notified the prime contractors that various portions of the work done under the contract for the Gruber Project had been inspected and accepted by the area engineer as they were completed and that final acceptance was being made as of the dates shown in the final payment estimate. The final payment estimate shows that the actual completion date of various portions of work ranged from June 1 to September 17, 1942, and that ‘clean up‘ was completed on October 14, 1942.
The Gruber Joint Venture kept only one set of books for the venture. It did not make any formal election as to when it would close its books of account, and it did not file any joint venture income tax or other information returns.
The contract of the Gruber Joint Venture for the Gruber Project was renegotiated in August 1943.
The operations of the Gruber Joint Venture were not reported in the income and declared value excess profits tax return filed by Oklahoma Standard on December 18, 1942, for the period January 1 to September 20, 1942. A like return filed by Delaware Standard for the fiscal year ended September 30, 1943, reported net income of $29,528.50, including profit in the amount of $155,488.34 realized from the Gruber Joint Venture, computed as follows:
+-----------------------------------------------------------------+ ¦Total net profit ¦ ¦$228,813.35¦ +--------------------------------------+--------------+-----------¦ ¦Less: ¦ ¦ ¦ +--------------------------------------+--------------+-----------¦ ¦Renegotiation refund ¦$41,666.67 (a)¦ ¦ +--------------------------------------+--------------+-----------¦ ¦Sale of equipment ¦31,658.34 (b) ¦73,325.01 ¦ +--------------------------------------+--------------+-----------¦ ¦ ¦ ¦155,488.34 ¦ +--------------------------------------+--------------+-----------¦ ¦(a) Respondent allowed as a deduction.¦ ¦ ¦ +-----------------------------------------------------+-----------¦ ¦(b) Respondent allowed $21,941.86 as a deduction. ¦ ¦ +-----------------------------------------------------------------+
In his determination of the deficiencies, respondent included the amount of $228,842.23 in gross income of Oklahoma Standard for the taxable period as income from the Gruber Joint Venture upon the ground that the Gruber Project was completed as of September 20, 1942.
At the close of September 20, 1942, the Dalhart Project was incomplete. Oklahoma Standard's portion of the total costs to that date was $442,251.98. By that date Oklahoma Standard had received from the United States $256,735.16 as partial payment on estimates of work performed under the contract and had earned ad additional $208,463.31 for work during the period August 11 to September 10, 1942, a check for which was received on September 25, 1942. At the close of September 20, 1942, the United States had withheld from Oklahoma Standard retainage in the amount of $51,688.71. Thereafter, the additional amount of $56,865.40 was retained. Of the total retainage of $108,554.11, $106,003.07 was paid under the estimate for the period December 26, 1942, to January 25, 1943. At that time it could not be determined with any degree of accuracy when the contract would be completed. The net amount received by Oklahoma and Delaware Standard under the contract was $633,544.17 and their total net costs were $515,760.20. The amounts are exclusive of amounts received for work done by subcontractors. On that date about 76.66 per cent of the total paid under the contract had been earned.
For a period of about three weeks, commencing September 21, 1942, the Dalhart Joint Venture, acting under orders of the United States, diverted part of the equipment being used by it on the Dalhart Project to another project being carried out by another contractor.
After September 20, 1942, the contract for the Dalhart Project was amended five times, three of which amendments provided for additional work at an increase of $22,481.19 in the contract price, and one covered an extension of 32 days within which to complete the work under the contract. No portion of the increase in contract price would be paid until the amendments were executed by both parties to the contract, which formality was completed in December 1942. The work performed under the contract by the Dalhart Joint Venture was finally accepted and approved on December 11, 1942, as of November 11, 1942, and final payment was made to it by the United States on June 29, 1943. The contract was renegotiated in June 1943.
The Dalhart Joint Venture elected the calendar year basis of reporting income and filed a joint venture tax return on a partnership return form on June 15, 1943, for the period ended December 31, 1942. The return contained no amounts as gross income or deductions. Attached to the return was a statement that the joint venture was formed to perform a contract for a Glider School, at Dalhart, Texas; that the total consideration for the contract, including changes, was $2,141,837.19, of which the amount assigned to the ‘Standard Paving Company‘ was $1,085,547.17; that books were kept by each coadventurer; that the method of accounting for each interest was the method selected by the respective coadventurers; and that the profit or loss to each on the contract would be the money taken into income when his or its work was completed, less his or its costs.
Oklahoma Standard did not report any income from the Dalhart Project in its income and declared value excess profits tax return for the period ended September 20, 1942. In its income and declared value excess profits tax return for the fiscal year ended September 30, 1943, Delaware Standard reported profit of $117,783.97 from the Dalhart Project. The profit of $117,783.97 was reported as the difference between cost of $515,760.20 and income of $633,544.17. In his determination of the deficiencies the respondent included $95,255.07 in gross income of Oklahoma Standard for the taxable period as accrued profit on the Dalhart Project, computed as follows:
+-----------------------------------------------------------------------------+ ¦Contract price ¦$633,544.17¦ +-----------------------------------------------------------------+-----------¦ ¦Estimated cost (based upon book cost at Sept. 20, 1942, as ¦533,275.67 ¦ ¦representing 95 per cent of estimated total cost) ¦ ¦ +-----------------------------------------------------------------+-----------¦ ¦Estimated profit ¦100,268.50 ¦ +-----------------------------------------------------------------+-----------¦ ¦Estimated profit at Sept. 20, 1942 (95 per cent of $100,268.50) ¦95,255.07 ¦ +-----------------------------------------------------------------------------+
At the close of September 20, 1942, Oklahoma Standard had not completed the Memorial Boulevard Contract and had earned 98.67 per cent of the total contract price. On that date it had received forming its contract. The amount retained by the State of Oklahoma to that date to secure performance of the contract was $9,027.70, of which $8,527.70 was paid on March 26, 1943, and the remainder on December 22, 1943.
The contract was completed on November 3, 1943, and the final payment was received by Delaware Standard on December 23, 1943.
In its return for the taxable period, Oklahoma Standard included in gross income the amount of $12,700.72 as profit realized from the Memorial Boulevard contract. The basis for including the amount as income for the taxable period was advice given by an employee in the accounting or engineering department of Oklahoma Standard to the outside accountant who prepared the return when the job was complete. No income from the contract was reported by Delaware Standard in its income and declared value excess profits tax return for the fiscal year ended September 30, 1943. Respondent did not, in his determination of the deficiencies, make any adjustments respecting income from the contract.
Based upon estimates of the amount earned for work done under the contracts to September 20, 1942, inclusive, including amounts actually paid under estimates for work performed during specified periods prior thereto, and the total amounts paid under the contracts, the percentage of completion of the Dalhart, Gruber, and Memorial Boulevard projects at the close of September 20, 1942, was about 76.66 per cent, 91.34 per cent, and 98.67 per cent, respectively.
On November 2, 1942, the Commissioner, pursuant to an application filed the previous month, gave Delaware Standard permission to change its accounting period from a calendar year to a fiscal year ending September 30, effective of September 30, 1942. Delaware Standard filed on December 15, 1942, an income and declared value excess profits tax return for the period from January 1 to September 30, 1942.
The excess profits tax return filed by Oklahoma Standard for the taxable period disclosed excess profits tax liability in the amount of $4,309, which was paid to the collector for the district of Oklahoma in four equal quarterly installments, commencing in December 1942. By waivers executed in November 1945 and April 1946, the time for assessment of taxes for the period ended September 20, 1942, was extended to June 30, 1947. On December 30, 1947, the petitioner in Docket No. 13006 filed with the collector for the district of Oklahoma a claim for refund of the $4,309 paid for excess profits tax in the taxable period.
By a letter dated February 2, 1942, the Oklahoma Tax Commission notified Oklahoma Standard that an audit of its corporation income tax return for the year 1938 disclosed additional tax due in the amount of $488.87. The notice contains a statement that Oklahoma Standard had acquiesced in the adjustments giving rise to the additional tax. The additional tax, plus interest, was paid by Oklahoma Standard on February 7, 1942.
Oklahoma Standard did not prior to the receipt of the notice have any knowledge of the amount of the additional tax.
In accordance with its practice of deducting deficiencies in state income taxes in the year in which the deficiency was agreed to and paid, Oklahoma Standard deducted the amount of the taxes in its income and declared value excess profits tax return for the period January 1 to September 20, 1942. The respondent disallowed the deduction in his determination of the deficiency.
OPINION.
DISNEY, Judge:
(1) Oklahoma Standard and Delaware Standard were on an accrual basis of accounting and reported income from long term construction contracts on the completed contract basis. The contracts entered into by Oklahoma Standard for the Gruber, Dalhart, and Memorial Boulevard projects
were incomplete at the close of September 20, 1942, when Delaware Standard succeeded Oklahoma Standard in a transaction the parties agree was a nontaxable reorganization under the provisions of section 112 of the Internal Revenue Code. Oklahoma Standard did not in its final return for the period ended September 20, 1942, report any income from the Gruber and Dalhart joint ventures, but included therein an amount for income derived from the Memorial Boulevard Project based upon the theory, thereafter found to be erroneous, that the contract had been completed. The income from the Gruber and Dalhart joint ventures was reported by Delaware Standard in its return for the fiscal year ended September 30, 1943, nothing reported as income from the Memorial Boulevard contract. In his determination of the deficiencies the respondent allocated to Oklahoma Standard a portion of the income from the Gruber and Dalhart ventures and made no adjustments in income derived from the other contract.
Reviewed by the Court. The contract for access roads at the Cookson Hills Cantonment is treated by the parties as part of the Gruber Joint Venture for purposes of taxation.
The first point for decision under the issue is whether Oklahoma Standard derived any taxable income from the contracts. The petitioners contend that without the nontaxable reorganization Oklahoma Standard would not have realized any taxable income under the three contracts at the close of September 20, 1942, and that the transaction occurring at that time did not change the result. Respondent's position, in general, is that the completed contract method of accounting does not clearly reflect income of a corporation from contracts in the course of completion at the time of its dissolution, as here, in a tax-free reorganization, and that the nontaxable reorganization does not affect the taxable income of Oklahoma Standard, and that, under sections 41 and 42 of the Internal Revenue Code, he had authority to determine its income under the circumstances existing on September 20, 1942, when that company closed business.
Petitioners assert that as all of the assets of Oklahoma Standard, including its interest in the joint ventures and the Memorial Boulevard contract, were transferred to Delaware Standard in the reorganization, and respondent admitted in his answer to the amended petition on Docket No. 13013 that neither corporation realized any taxable gain nor sustained loss in the reorganization, the admission constitutes a concession that Oklahoma Standard realized no income at the close of September 20, 1942, from the joint ventures or the Memorial Boulevard contract. No authority is cited by the petitioners to support their contention other than section 29.22(a)-20 of Regulations 111, which is to the effect that a corporation realizes no gain or loss in the mere distribution of its assets in kind in complete liquidation.
Petitioners' argument fails to recognize the statutory distinction between income earned by ordinary operations and gain in a disposition of property in a transaction that terminated the existence of the corporation. The respondent is not attempting to assert a tax against Oklahoma Standard on gain realized from a transfer of assets in the tax-free reorganization. All he seeks to do, briefly stated, is to assess a tax against Oklahoma Standard for income earned by it under the contracts prior to the reorganization. Gain, the excess of the amount realized in a sale or other disposition of property over the allowable basis, is not involved in the question.
Similar facts were present in Jud Plumbing & Heating, Inc., 5 T.C. 127; affd., 153 Fed.(2d) 681. The corporation involved therein was on an accrual and the completed contract bases of accounting and at the time of its liquidation had a number of long term contracts in the course of completion. Upon the dissolution of the corporation on August 31, 1941, all of its assets were transferred to the owner of substantially all of the corporation's stock, who assumed the liabilities and agreed to complete the contracts. Thereafter in 1941 the work was completed by the former stockholder. The corporation did not include in its final return any income arising from the incompleted contract so transferred. The income from the contracts was included in the return of the individual former stockholder for 1941. The Commissioner, as here, allocated a portion of the income derived from four of the contracts to the corporation on the theory that such action was necessary to clearly reflect its income, citing section 41 of the Internal Revenue code.
The other contracts were ignored by him.
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. * * *
The petitioner contended that, under the corporation's method of accounting and reporting income on the completed contract basis, the corporation derived no income from the contracts prior to dissolution and that the Commissioner was without authority to change the corporation's accounting method because of its liquidation.
In sustaining the action of the Commissioner, we pointed out that a consistent method of reporting income by the completed contract method clearly reflects income ‘if the taxpayer continues in existence‘ and that the adjustments made by the Commissioner were authorized by section 41, supra, and consistent with the rule that ‘income is taxable to him who earns it.‘ The Circuit Court of Appeals, in affirming this Court, remarked that where the voluntary act of a corporation prevents the completion of a long term contract, it is not in a position to insist that its income is free of tax or that its tax liability on such contracts can be measured only at time of completion, and that the dissolution of a corporation during the course of completing a long term contract is a detail not covered by the completed contract method of accounting.
It seems apparent from the facts that Oklahoma Standard had earned income from the contracts prior to the reorganization. At that time, when the Gruber Project was about 91 per cent complete, the joint venture had received, in partial payments for work performed, about $2,210,000, against costs to that date of about $1,955,000, and about $128,000 was being withheld for retainage and liquidated damages. The Roads Project was completed prior to the reorganization, although notice of final acceptance was not given by the United States until December 3, 1942. Except for ‘clean up‘ operations, the work on the Gruber Project was completed prior to the reorganization, according to an inspection made by the area engineer, and final acceptance, given on May 10, 1943, was made as of dates prior to the reorganization. However, the respondent does not contend that the Gruber Project was completed on September 20, 1942, to the extent of more than 91.34 per cent. The amounts received and earned to September 20, 1942, on the Dalhart Project exceeded costs by about $28,000, and the percentage of completion was about 76.66. Likewise, receipts from and retainage in the Memorial Boulevard contract, on September 20, 1942, were about $13,000 in excess of costs to the date. If the theory of petitioners were given its full effect, no income would be derived by a transferor corporation, as here, even though on the crucial date all of the work specified in the contract had been performed and nothing remained except final acceptance and receipt of remaining contract payments. Furthermore, it would enable a parent corporation to evade tax by absorbing in a nontaxable reorganization a subsidiary about to realize income from incompleted contracts. Clear legislative sanction would be required to create such a distortion of income.
Commissioner v. Sansome, 60 Fed.(2d) 933, cited by petitioners, involved tax to a stockholder on earnings of a corporation upon the distribution thereof on dissolution of its successor, not a tax to the predecessor corporation on the income when earned by it. Commissioner v. Phipps, 167 Fed.(2d) 117, concerned the treatment, in determining earnings available for distribution to stockholders, of a surplus and deficits acquired by a corporation in a tax-free reorganization, a question similar to the one in the Sansome case. The Supreme Court, in reversing the decision, concluded that ‘the Sansome rule is grounded not on a theory of continuity of the corporate enterprise but on the necessity to prevent tax evasion.‘ Commissioner v. Phipps, 336 U.S. 410. Such conclusion is opposed to the theory of petitioners that a tax-free reorganization prevented respondent from changing the method of reporting income on contracts incompleted at the time of its dissolution. Sections 113(a)(15, 44(d), and 117(h) of the Internal Revenue Code, relating to the basis for property, profit on installment sales, and the holding period for capital assets, involved in a nontaxable reorganization, are in keeping with the general rule that such transactions merely defer gains otherwise taxable, because of a continuity of interest. They relate to situations growing out of the reorganization itself and not, as here, to matters producing income before a plan of reorganization was prepared and carried out.
One of the grounds upon which petitioner seeks to distinguish the Jud case is that it did not involve a nontaxable reorganization. We do not think that distinction in the facts is sufficient reason to decline to follow it here. Oklahoma Standard, as in the case of the corporation in the Jud case, did dissolve and such action terminated the method theretofore consistently followed of reporting income on long term contracts, leaving in its hands income in the process of accrual on which no tax had been paid. Had Delaware Standard, the parent corporation, elected to dissolve its subsidiary without a tax-free reorganization, the earnings from incompleted contracts would fall squarely within the rule in the Jud case. Its choice of methods to put Oklahoma Standard to death may not be used to defeat a tax on income earned during the last taxable period of the corporation's life. Any method of accounting must clearly reflect income. We find nothing in the reorganization provisions of the statute deferring to a future date tax on income earned under an accrual method of accounting. The reorganization prevented Oklahoma Standard from continuing its completed contract method of reporting income on long term contracts. Obviously, another method was necessary clearly to reflect its income. A change to a strict accrual method was made by the respondent, action having statutory authority in section 41, supra.
That section has been variously construed as granting a broad power to the Commissioner. Thus, in Rouss v. Bowers, 30 Fed.(2d) 628, affirming 4 B.T.A. 516, a case in some respects similar in principle to this a sole proprietor, on an accrual basis, took inventories and determined profits as of June 30 and December 31 of each year. On May 13, 1918, he organized a corporation to which the business was transferred. The books were not closed on that date. The corporation reported the income of the business for the entire calendar year, while the sole proprietor reported none of it. The Commissioner was upheld in assessing, under the predecessor of section 41, to the proprietor on the basis of the business income in proportion to the number of days in the year, before the transfer, in the absence of showing of the true profits. In C.L. Carver, 10 T.C. 171; affd., 173 Fed.(2d) 29, we approved the Commissioner's action under section 41 in recomputing petitioner's income on the accrual basis, instead of the cash basis used by the petitioner in computing net income, though he had changed his books to the accrual basis. We quoted William Hardy, Inc. v. Commissioner, 82 Fed.(2d) 249: ‘In deciding what method is necessary clearly to reflect a taxpayer's income, the commissioner is given a breadth of discretion which, though not unlimited, will be reviewed here only when abuse of it is clearly shown, ‘ citing Brown v. Helvering, 291 U.S. 193; Lucas v. American Code Co., 280 U.S. 445. In Rosa Orino, 34 B.T.A. 726, the petitioner, engaged in the contracting business, kept books on an accrual basis, and set up cash received on Government contracts, and amounts of earned percentages retained by the Government pending contract completion. The Commissioner determined under section 41 that this method reflected income, and in the absence of contrary showing we affirmed, irrespective of whether the contracts were long term, and despite the fact that in a later year it developed, due to loss from fire, that less than contract price was received, and despite the general fact that work on the contracts sometimes has to be redone.
The exercises of authority by the Commissioner under section 41 in the instant case seems well within the range indicated by the above cases.
Moreover, it seems plain that a situation such as arises here, from nontaxable reorganization of a corporation on a completed contract basis, is one calling for application of section 41. The gist of that section is proper reflection of income. The petitioner, in effect, urges that the reorganization, being nontaxable, left the new corporation precisely in the shoes of the old, so that it can report the income on the long term basis. But this view would deny the new corporation a right to select its own method of accounting. What if it chose to follow the percentage of completion method? It would have that right, subject, at most, to permission from the Commissioner—if the new method properly reflected income. But if a new method of accounting such as as percentage of completion omitted from income some percentage completed before the reorganization, it is clear that the Commissioner could act under section 41. Yet here he is doing nothing more, for it is obvious that he considers his action to be within the statute. If the Commissioner can refuse the new corporation a change of accounting method in order to assure proper reflection of income, we think he can under section 41 prescribe that income shall fall upon the transferor and transferee so that income will not be distorted. That is the action he has taken.
Another ground urged by the petitioners against taxing to Oklahoma Standard any amount as profit earned under the contracts is that for various reasons, including retainage, liquidated damages, change orders, and renegotiation, it was impracticable at the close of September 20, 1942, to endeavor to make any determination of ultimate profit.
The completed contract method does not require completion of more than all important particulars called for by a contract. Ehret-Day Co., 2 T.C. 25, 34; Mesta Machine Co., 12 B.T.A. 523. Under all the circumstances before us here, an attempt, under section 41 of the Internal Revenue Code, to allocate earned income between successive corporations seems to require no essentially different treatment. Bent v. Commissioner, 56 Fed.(2d) 99, cited by the petitioners, involved the right to change from a completed contract method consistently followed by a going partnership of which the taxpayer there was a member, to an annual accrual basis, and not, as here, the dissolution of the contractor during the course of completion of a long term contract. The remarks of the court concerning the indefiniteness of the financial outcome of long term contracts were made to illustrate that receipts thereunder do not necessarily reflect profit.
The corporation involved in Guy M. Shelley, 2 T.C. 62, kept its books on an accrual basis, using the completed contract method for reporting income on long term contracts. After completing a long term contract, except for a test run and receiving the final payment, and filing a certificate of dissolution, the corporation distributed income from the contract directly to its stockholders. We held that the income from the long term contract was taxable to the corporation. Such conclusion had the effect of placing the corporation on a strict accrual basis.
Involved in the issue, to the extent that it applies to the Gruber and Dalhart projects, is the question of whether the fact that the joint ventures were entered into to perform the contracts produces a different result. Petitioners argue that the joint ventures continued without change until 1943, when the contracts were renegotiated; that the reorganization did no more than effect a transfer of the interest of Oklahoma Standard in the joint ventures to Delaware Standard; that the joint ventures were on the calendar year basis of accounting and, accordingly, none of the joint ventures realized any income prior to the close of 1942.
Respondent's position is that, as the code treats joint ventures as partnerships for Federal taxation, the dissolution of Oklahoma Standard terminated the joint ventures on September 20, 1942. Petitioners argue that the code is silent on the dissolution of a joint venture or what occurs when a coadventurer transfers his interest. They say that the power to legislate on such matters is vested in the states and that in Oklahoma the transfer of an interest in a joint venture does not dissolve the enterprise and a corporation may not be a member of a partnership. Thus, petitioners say, in effect, that the code provision classifying joint ventures as partnerships for Federal taxation purposes is inapplicable because local law governs and, in Oklahoma, Oklahoma Standard could not be a partner.
‘ * * * State law may control only when the operation of the Federal taxing act, by express language or necessary implication, makes its own operation dependent upon state law. * * * The state laws creates legal interests, but the Federal statute determines when and how they shall be taxed.‘ Burnet v. Harmel, 287 U.S. 103.
Section 3797(a)(2) of the Internal Revenue Code defines the term ‘partnership‘ as including a joint venture and the term ‘partner‘ as including a member of a joint venture. Subsection (a)(1) defines the term ‘person‘ as including a corporation, unless otherwise distinctly expressed.
The Senate Committee on Finance in Senate Report No. 665, said that the purpose of including the counterpart of section 3797(a)(2) in the 1932 Act was to place joint venturers in the category of partnerships ‘and the members of such syndicates, pools, etc., in the category of partners.‘ This Court has said that joint ventures and partnerships ‘from the standpoint of the Federal tax laws amounts to the same thing.‘ James F. Curtis, 3 T.C. 648, 662. Under the circumstances, it is obvious that the question here is not, as argued by petitioners, dependent upon state law, but is controlled by the applicable Federal statute. Lucas v. Earl, 281 U.S. 111; Helvering v. Clifford, 309 U.S. 331; Burk-Waggoner Oil Assn. v. Hopkins, 269 U.S. 110; Commissioner v. Tower, 327 U.S. 280.
Moreover, we find upon examination of local law that, although in Oklahoma a corporation may not become a member of a general partnership, Municipal Paving Co. v. Herring, 50 Okla. 470; 150 Pac. 1067; Kasiske v. Baker, 146 Fed.(2d) 113, ‘The law of partnership applies in settlement of questions arising among the parties, and in relation to third parties‘ with respect to joint ventures. O. K. Boiler & Welding Co. v. Minnetonka Lumber Co., 103 Okla. 226; 229 Pac. 1045; Twyford v. Sonken-Galamba Corporation, 177 Okla. 486; 60 Pac.(2d) 1050; Taylor v. Brindley, 164 Fed.(2d) 235. In Oklahoma a general partnership is dissolved upon the transfer of a partnership interest to a nonpartner. Title 54, sec. 45, Oklahoma Stat. 1941, sec. 11652, Oklahoma Stat. 1931.
By placing Oklahoma Standard in the category of a partner, as required by the Federal statute for purposes of taxation, we find that the transfer of its interest in the joint ventures to Delaware Standard caused the dissolution thereof and required an accounting for profits distributable to the retiring member during the last taxable period of its membership. Guaranty Trust Co. v. Commissioner, 303 U.S. 493; Darcy v. Commissioner, 66 Fed.(2d) 581; Louis Karsch, 8 T.C. 1327. Such a distributable income was not in any sense a return of capital for use in computation of gain or loss, deferred or otherwise, for no tax had been paid on it.
The transfer by Oklahoma Standard of all of its assets to Delaware Standard included in the joint ventures and the construction contracts being carried out by them. But the transferor had earned a right to a portion of the profits of the joint ventures prior to the dissolution and such distributable income may not be assigned without tax liability. Helvering v. Horst, 311 U.S. 112, is an example of that well establish rule.
The members of the Gruber Joint Venture agreed to close the books of the venture as soon as possible after completing the Gruber Project. However, the venture made no formal election in the matter and filed no return, even though the Roads Project was completed prior to the reorganization, and there was at least a preliminary acceptance of the work on the Gruber Project. Concerning the Dalhart Joint Venture, there was a division of the work among the coadventurers, with a separate accounting by each. The plan adopted did not require any of the coadventurers to await the outcome of the whole project before computing its profit or loss. If the joint ventures were on the completed contract method of accounting the result would be no different than the status of Oklahoma Standard with respect to the Memorial Boulevard contract, for the dissolution of the joint ventures would have required to the respondent to place them on a strict accrual basis in order clearly to reflect income. We find nothing in the fact that the Gruber and Dalhart projects were being carried out by joint ventures to require a conclusion different from that reached as to taxable income of Oklahoma Standard from Memorial Boulevard contract.
The parties differ on the method to be used in determining the amount of income accruable to Oklahoma Standard under the joint ventures and Memorial Boulevard contract as of the close of September 20, 1942. Their respective methods are:
+---------------------------------------------------------------+ ¦ ¦Gruber ¦Dalhart ¦Memorial ¦ +-------------------------+-----------+--------------+----------¦ ¦ ¦ ¦ ¦Boulevard ¦ +-------------------------+-----------+--------------+----------¦ ¦Petitioner: ¦ ¦ ¦ ¦ +-------------------------+-----------+--------------+----------¦ ¦Received and earned ¦$736,615.32¦$465,198.47 ¦$81,249.37¦ +-------------------------+-----------+--------------+----------¦ ¦Costs ¦651,862.18 ¦487,614.45 ¦77,576.35 ¦ +-------------------------+-----------+--------------+----------¦ ¦Income ¦84,753.14 ¦* (22,415.98)¦3,673.02 ¦ +-------------------------+-------------------------------------¦ ¦ ¦ ¦ +-------------------------+-------------------------------------¦ ¦Respondent: ¦ ¦ ¦ ¦ +-------------------------+-----------+--------------+----------¦ ¦Net profit ¦228,813.35 ¦117,783.97 ¦12,700.72 ¦ +-------------------------+-----------+--------------+----------¦ ¦Percentage completion ¦91.34 ¦76.66 ¦98.67 ¦ +-------------------------+-----------+--------------+----------¦ ¦Net profit Sept. 20, 1942¦208,998.11 ¦90,293.19 ¦12,531.80 ¦ +---------------------------------------------------------------+
FN* Loss.
In determining the deficiencies respondent included in gross income of Oklahoma Standard the amount of $228,842.23
as income from the Gruber Joint Venture and $95,255.07 from the Dalhart Joint Venture, based upon the theory that the contracts were fully and 95 per cent completed, respectively. Oklahoma Standard included $12,700.72 in its income as profit from the Memorial Boulevard contract, and respondent made no adjustments of the figure. The lessor amounts now being asserted by respondent as allocable to Oklahoma Standard are based upon evidence produced at the hearing on the degree of completion of the construction contracts on September 20, 1942.
Respondent now agrees that $228,813.35 is the correct net profit realized from the contract.
Petitioners first urge upon brief that the admission of respondent to the effect that the evidence establishes a lesser degree of completion of the contracts than the percentages determined by him when asserting the deficiencies, amounts to a confession of error and requires us to find and hold that there is no deficiency. They regard his present position as an abandonment of the deficiencies here in question and the assertion of a new deficiency, for which there is no provision in the code. Disagreement with them on the point is then said to require a ruling of the Court that respondent deprived himself of the presumption of correctness of his deficiencies, and that the petitioners were relieved of the burden of proof. No authority is cited in support of the contentions.
There was no abandonment by respondent before or during the hearing of his original position and, at the hearing, each party submitted testimony on the general issue. The view of respondent upon brief is, in effect, no more than that the evidence in the record establishes that the degree of completion of the contracts was less than the percentages determined by him and reported by Oklahoma Standard in the case of the Memorial Boulevard contract. At most, it is an admission on his part, irrespective of the burden of proof, that the evidence is against him to a specified degree. Such a conclusion, reached from his estimate of the weight of the evidence, can not be stretched to the lengths urged by petitioners. If it could be, respondent would be at all times compelled to urge affirmation of his entire deficiency or lose everything under an admission, after the evidence was in, that an error of judgment, however, small, had been committed.
Petitioners' contention, as we understand it, would embrace an unrelated issue— The Oklahoma state income tax deduction question— and make it unnecessary for us to decide the issue on whether Oklahoma Standard was wrong in reporting income from the Memorial Boulevard contract, as to which respondent made no determination other than to treat the return as correct in that respect. In spite of the views of petitioners, they ask us to find as a fact that about 76.66,91.34, and 98.67 per cent of the Dalhart, Gruber, and Memorial Boulevard contract prices, respectively, had been earned at the close of September 20, 1942, and admit income from the Gruber and Memorial Boulevard contracts prior to September 20, 14942, if an allocation is required and their method of computing the income is accepted by us.
We find no logical reason to conclude that the present position of the respondent, based upon the evidence of record, as distinguished from facts forming a basis for his original determination, shifted the burden of proof. There has been no abandonment or repudiation of the deficiencies, coupled with arbitrariness in the original determination, as in Tex-Penn Oil Co. v. Commissioner, 83 Fed.(2d) 518. The duty of this Court ‘is to weight the evidence and declare the result as to matters properly before it,‘ Helvering v. Kehoe, 309 U.S. 277, and in doing so we must consider the entire record, irrespective of which party in the proceeding had the burden of proof.
It will have been observed the petitioners' method of computing profit under the contracts involves only receipts and costs to September 20, 1942, without taking into account any subsequent events, and respondent's method, simply stated, allocates the final profit, about which there is no controversy, on the basis of percentage of completion on that date. Neither party regards their or his method as mathematically accurate. Petitioners point out that their method takes into account only amounts to be considered in an accrual method of accounting, thereby eliminating amounts received with respect to estimates for periods ended after September 20, 1942, also retainage and liquidated damages, which, it is urged, were not taxable income on the crucial date under the rule of Cleveland, Trinidad Paving Co. (Ohio), 20 B.T.A. 772; affd., 62 Fed. (2d) 85, and similar cases. Respondent opposes petitioners' method on the ground that it includes costs for unused material on hand on September 20, 1942, as to which there is no evidence.
Petitioners use the figure $487,614.45 as cost to September 20, 1942, in arriving at a loss of $22,415.98 as of that date on the Dalhart Project. Such cost is shown in a statement allegedly prepared from the books of the joint venture. The same statement discloses total costs of $965,063.16 to complete the contract. The testimony is that the costs incurred by Oklahoma Standard to September 20, 1942, were $442,251.98 and the return filed by Delaware Standard shows total costs of $515,760.20. There is indication that the figure of $487,614.45 includes costs of subcontractors. In making our findings on the costs, we have followed the testimony and return. By correcting petitioners' computation on brief, we find profit of about $23,000, instead of a loss.
In urging us to disregard retainage, petitioners, in effect, treat the question as though our problem were simply whether the amounts were accruable during the course of completion of long term contracts by a single corporation. More is involved. The work was undertaken by Oklahoma Standard and completed by Delaware Standard. The amounts retained for work done by the former was paid to the latter without effort on its part, and there would be a distortion of income, under the facts here, unless it is taxed to the corporation that earned it.
Oklahoma Standard accrued such retainage under the Memorial Boulevard contract when reporting income therefrom, even though all of it was not paid until December 1943. Such action discloses its judgment on the ultimate right to receive the amount.
In the contracts for the Gruber and Dalhart projects provisions were inserted under the terms of which retainage could be paid prior to completion of the work. About $49,000 was paid to the Gruber Joint Venture in June 1942, and the additional amount of about $109,000 before the close of that year. An amount for retainage in excess of the retainage outstanding on September 20, 1942, was paid to the Dalhart joint venture about the close of the year.
In the Jud case, the respondent determined the state of completion of the contracts on the basis of costs to the date of transfer and total costs and applied the ratio between them to total profits, to compute the profit to the date of transfer. Payments there, as here, were made to the contractor on the basis of estimates submitted during the course of completion of the contracts, and were less ‘retainage.‘ The method was regarded by this court as ‘probably the best method of determining the correct allocation of the profits from each contract‘ under the circumstances and was not disturbed in the absence of proof of a better method.
The method advanced by petitioners ignores the final profit, which, in the final analysis, is the amount to be taxed. The Memorial Boulevard contract was practically completed on September 20, 1942, yet only 29 per cent of the profit thereunder is included in the income of Oklahoma Standard under petitioners' plan. As to the Gruber Project, petitioners include about 73 per cent of the profit of $155,488.34 as income earned to the time the contracts were about 91 per cent completed. The discrepancy is much greater if the renegotiation refund, the amount of which was unknown on September 20, 1942, is taken into account. A like situation prevails as to the Dalhart Project. Moreover, on the basis of the final notices of acceptance, the Roads Project was completed and the Gruber Project was substantially completed prior to the reorganization. Notices of the completion of the Roads and Dalhart projects were given before the filing of the final return of Oklahoma Standard. The respondent eliminates uncertainties about the final financial outcome of the contracts and allocates the profits on a percentage of completion having a reasonable basis under the circumstances prevailing here.
Petitioners assert that respondent's computation overstates the actual profits from the Gruber Joint Venture by $73,325.01, and infers that the percentage should be applied to the net profit of $155,488.34, which was reported as profit after deducting $73,325.01 for a refund made under renegotiation and loss on sale of equipment. Oklahoma Standard's share of the refund, amounting to $41,666.67, was eliminated from income by the respondent in his computation of the deficiencies and a deduction, reduced to $21,941.86, was allowed for loss on sale of the equipment, in view of which the total taxable to both corporations will not exceed the lower figure of $155,488.34.
Accordingly, we hald that Oklahoma Standard realized taxable income in the amount of $208,998.11 from the Gruber Joint Venture; $90,293.19 from the Dalhart Joint Venture, and $12,531.80 from the Memorial Boulevard contract.
(2) Petitioners contend that the net operating loss which will result from a shifting of income from Delaware Standard for the year ended September 30, 1943, to Oklahoma Standard for the taxable period ended September 20, 1942, is deductible by Oklahoma Standard. They assert, without discussion, that the nontaxable reorganization brings the deduction within the provisions of section 23(s) and 122 of the code.
Respondent contends that net operating losses are deductible as carry-backs only by the same taxpayer and the result is not changed by a tax-free reorganization.
Section 23(s) allows as a deduction in computing net income ‘the net operating loss deduction computed under section 122.‘ Section 122, to the extent material here, provides in subsection (b)(1) that ‘If for any taxable year beginning after December 31, 1941, the taxable has a net operating loss, such net operating loss shall be a net operating loss carry-back for each of the two preceding taxable years * * *.‘
It is well established that deductions may not be taken without clear legislative authorization. In New Colonial Ice Co. v. Helvering, 292 U.S. 435, the petitioner upon its organization in 1922 took over the assets and liabilities of a corporation which had sustained statutory net losses in 1921 and 1922 prior to the transfer. The corporate existence of the old corporation continued in 1922 and 1923. The Court pointed out that ‘the statutes have disclosed a general purpose to confine allowable losses to the taxpayer sustaining them.‘ The applicable statute provided to the extent material, that if ‘any taxpayer has sustained a net loss, the amount thereof shall be deducted from the net income of the taxpayer for the succeeding taxable year.‘ The Court, in denying the deductions, held that the provision meant that the taxpayer who sustained the loss is the one to whom the deduction shall be allowed.‘ It further held under an alternative contention that the deductions were not allowable upon the asserted ground that for all practical purposes the two corporations were the same taxpayer.
In the Phipps case, supra, the Court declined to recognize deficits of retiring corporations in a nontaxable reorganization as deficits of the continuing corporation.
We cited the New Colonial case in Michael Carpenter Co., 47 B.T.A. 626, where there was a tax-free reorganization. The new corporation acquired the assets and business of the old, including claims for reimbursement from certain mills. We held that amounts received by the new corporation on settlement of the claims were income to it, stating that the situation was comparable to one involving deduction of statutory net loss by an entity separate from the one sustaining, and that a loss by the old corporation was not transferable to or useable by the new corporation.
In Winter & Co. (Indiana), 13 T.C. 108, the taxpayer did not engage in any business operations after April 30, 1942, and, under the prevailing circumstances, in a practical sense ceased to exist. We held that taxable periods after April 30, 1942, were not included in the taxpayer's cycle of years for the carry-back of unused excess profits tax credits, and that the taxpayer could not have an operating loss in 1944 for carry-back purposes.
Here Oklahoma Standard was dissolved in September 1942 and thereafter ceased to exist as a corporate entity. It did not have, and, as it was not in existence, could not have had, an operating loss during the fiscal year ended September 30, 1943.
We know of no statutory provision relating to nontaxable reorganizations in any way altering the rule in the New Colonial Ice Co. case. The transaction her, instead of continuing the life of Oklahoma Standard, put it to death. To allow Oklahoma Standard to deduct the loss sustained by Delaware Standard in a subsequent year would call for the recognition of the former not only as a continuing corporation, but with a right to take deductions sustained by another corporation after it ceased to exist. Had Congress intended to confer such an unusual tax benefit, it is believed it would have expressed it in clear language.
We find nothing in Stanton Brewery, Inc. v. Commissioner, 176 Fed.(2d) 573, reversing 11 T.C. 310, helpful to petitioners. There the question was whether the taxpayer, the resulting corporation after a merger, could carry over, under the provisions of section 710(c)(3)(B) of the code,
in determining its excess profits net income, the unused excess profits credit of one of its components for the two years prior to the merger. The Court allowed the carryover upon the broad ground that there was essentially a continuing enterprise and that the union of the corporations carried with it the rights and obligations of the component corporations. The conclusion was induced by the liability of the taxpayer for taxes of the former corporations. The result of the decision was to treat the petitioner therein as ‘the taxpayer‘ within the meaning of section 710(c)(3)(B).
SEC. 710. IMPOSITION OF TAX.(c) UNUSED EXCESS PROFITS CREDIT ADJUSTMENT.—(3) AMOUNT OF UNUSED EXCESS PROFITS CREDIT CARRY-BACK AND CARRY-OVER.—(B) Unused Excess Profits Credit Carry-Over.— If for any taxable year beginning after December 31, 1939, the taxpayer has an unused excess profits credit, such unused excess profits credit shall be an unused excess profits credit carry-over for each of the two succeeding taxable years * * * .
There is no basis here for following the reasoning of the Circuit Court in the Stanton Brewery, Inc., case, even assuming that we agreed with that case. The question is not one of the status, in the hands of a transferee corporation, of a deduction earned by a transferor corporation, but the reverse thereof, and involves a loss not sustained until after the transferor corporation ceased to exist. The reorganization here, it is true, continued the enterprise, yet Oklahoma Standard, instead of acquiring rights and assuming obligations, gave up everything it had in the reorganization in favor of Delaware Standard. The operating loss involved herein resulted from operations of the surviving corporation after the transfer and is not associated in any way with business conducted by Oklahoma Standard during its existence. Thus, we do not have a benefit to continue in favor of a succeeding corporation, but a loss of another corporation that did not come into existence until after Oklahoma Standard ceased as a corporation.
On this issue we hold for the respondent.
(3) Oklahoma Standard, which used an accrual basis of accounting and reporting income, seeks as a deduction in the taxable period additional Oklahoma income taxes assessed and paid in such period for the year 1938.
It is well established that taxes accrued for deduction purposes when all of the events occur to fix the amount thereof and determine the liability to pay it. United States v. Anderson, 269 U.S. 422; Uncasville Mfg. Co. v. Commissioner, 55 Fed.(2d) 893; Keller-Dorian Corporation v. Commissioner, 153 Fed.(2d) 1006; Rawlings Manufacturing Co., 44 B.T.A. 161; Oregon Pulp &Paper Co., 47 B.T.A. 772, 780; Burton-Sutton Oil Co., 3 T.C. 1187, 1196; Great Island Holding Corporation, 5 T.C. 150. Here all of the events occurred in 1938 to fix the amount and the liability to pay. The failure of Oklahoma Standard to report its correct income tax liability does not alter the situation, for the discovery of the error related back to the year when the mistake was made. Haverty Furniture Co., 20 B.T.A. 644. That Oklahoma Standard did not know of the amount of the additional tax until 1942, does not control. The same was true in Oregon Pulp & Paper Co., supra, yet we denied deduction of taxes paid, which had, however, accrued in an earlier year.
However, Oklahoma Standard contends that the additional taxes were deducted in the taxable period in accordance with a consistent practice, and that such departure from the method of accounting regularly employed by it is permissible in the absence of proof that the isolated departure from the usual method distorted income. The decisive question is the year in which the tax is deductible under the governing statute. That year, as already shown, is 1938. Allowance of the amount as a deduction in the taxable period is not only opposed by a well established rule, but, in our opinion, would distort, rather than correctly reflect, income for such period.
On this issue we hold for the respondent.
Oklahoma Standard did not in its petition contest the respondent's determination against it for the year 1941. The transferee liability asserted by the respondent for that year and the taxable period in 1942 was placed in issue by Delaware Standard, but no specific errors were alleged in computing the deficiency of $104.67 in income tax against Oklahoma Standard for 1941. Such errors as Delaware Standard alleged concerned tax liability of Oklahoma Standard and upon brief it does not contest its liability as a transferee for any deficiencies determined against the transferor. Accordingly, we find that Delaware Standard is liable as a transferee for the deficiency of $104.67 in income tax for 1941, and the deficiencies in declared value excess profits tax and excess profits tax for the taxable period January 1 to September 20, 1942, will be computed and
Decision will be entered under Rule 50.