Western Cartridge Co.
v.
Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.Sep 13, 1948
11 T.C. 246 (U.S.T.C. 1948)

Docket No. 9670.

1948-09-13

WESTERN CARTRIDGE COMPANY (NOW: OLIN INDUSTRIES, INC.), PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

George E. H. Goodner, Esq., and Scott P. Crampton, Esq., for the petitioner. Gerald W. Brooks, Esq., for the respondent.


1. In 1940 and 1941 taxpayer entered into three contracts with the United States. Under the terms of the 1940 contract the Government, upon request of taxpayer, was to make advance payments not to exceed 30 per cent of cost of procurement and installation of manufacturing facilities. Under the two 1941 contracts the Government was to make advance payments of 30 per cent of the purchase or contract price of certain products manufactured by taxpayer. Taxpayer, at its request, reimbursed the Government by check for a portion of the advance payments under the 1940 contract in lieu of crediting against advance payments the amount of unpaid invoices or nonpayment vouchers. Reimbursement of advance payments under the two other contracts was made by a credit of 30 per cent on the purchase price of products invoiced and delivered to the Government, the latter paying to taxpayer the remaining 70 per cent. Held, the advance payments did not constitute ‘indebtedness‘ of taxpayer and, therefore, it is not entitled to a credit for debt retirement under section 783 in the amount claimed.

2. Taxpayer paid Connecticut income tax of $562,213.71 for 1942, reserving in its return the right to file an amended return after completion of pending renegotiation proceedings. In 1944 taxpayer filed an amended return and also a claim for refund of $320,738.30. No action has been or will be taken in respect to such claim or otherwise by state tax authorities until receipt of notice of determination of taxpayer's taxable net income for Federal income tax purposes. Held, in determining its income tax liability for 1942 taxpayer is entitled to a deduction of the amount of the 1942 state income tax paid. George E. H. Goodner, Esq., and Scott P. Crampton, Esq., for the petitioner. Gerald W. Brooks, Esq., for the respondent.

The Commissioner determined a deficiency in petitioner's excess profits tax in the amount of $2,997,824.72 for the year 1942. The issues are (1) whether repayment during 1942 of certain moneys received by petitioner from the Chief of Ordnance, War Department, under three war contracts to purchase and install machinery for the St. Louis Ordnance Plant and to manufacture cartridges at New Haven, Connecticut, entitled petitioner to a credit for debt retirement under section 783 of the Internal Revenue Code; (2) whether the deduction allowed for state income taxes should be decreased due to renegotiation of petitioner's war contracts by the Price Adjustment Board of the War Department; and (3) whether petitioner is entitled to have payment of $1,119,594.43 made on February 3, 1945, applied to reduce the deficiency determined by the Commissioner on August 30, 1945. Other issues raised were waived or settled by stipulation. Effect will be given thereto in the recomputation under Rule 50. By affirmative allegations, the Commissioner makes claim for an increase in the deficiency of not less than $251,064.30. Petitioner claims overpayment of excess profits taxes.

FINDINGS OF FACT.

Most of the facts were stipulated. The stipulation, together with all exhibits thereto attached, is incorporated herein by reference. The following is a summary of the pertinent stipulated facts, together with other facts otherwise found from the record:

Petitioner is a Delaware corporation, with its principal place of business at East Alton, Illinois. At the end of 1944 a reorganization was consummated whereby Ohio Corporation, a Maryland corporation, was merged with petitioner. All of the assets of Olin Corporation were transferred to, and all its liabilities were assumed by, petitioner. At the same time, petitioner's corporate name was changed to Olin Industries, Inc., and its capital stock was increased, but petitioner continued to be the same corporation organized on January 25, 1922, under the name of Western Cartridge Co., except that its name was changed to Olin Industries, Inc.

Since its incorporation in 1922, petitioner has been engaged in the manufacture of ammunition and other products.

Petitioner keeps its books and files its Federal income and excess profits tax returns on the accrual basis of accounting and by calendar years. On or about June 12, 1943, it filed its Federal income and excess profits tax returns for the year 1942 with the collector of internal revenue at Springfield, Illinois.

Since 1940 and prior thereto, petitioner has operated a branch business at New Haven, Connecticut, under the name of Winchester Repeating Arms Co., but as a division of petitioner. Hereinafter such division of petitioner will be referred to as Winchester and the division of petitioner at East Alton, Illinois, will be referred to as Western.

Under date of December 5, 1940, Western, designated as the ‘Contractor,‘ entered into a contract, numbered W-ORD-481 with The United States of America, represented by certain contracting officers, for:

Management service covering supervision, direction and control of the production aspects of the layout, engineering and construction (including plant and equipment layouts) of a plant for the manufacture of Caliber .30 and Caliber .50, Small Arms Ammunition of certain types; training of key personnel; and procurement, supervision of layout and supervision of installation (including supervision of plans therefor) of manufacturing facilities

at St. Louis, Missouri. This contract was approved by direction of the Secretary of War on December 14, 1940. Under Title I of the contract, Western was to receive $313,000 for management service, under Title II, $1,300,000 for training of key personnel, and under Title III, its cost or reimbursement for expenditures as provided in Title IV, estimated at $16,500,000, plus a fixed fee of $495,000 as compensation for its services, including profit.

Article III-A— STATEMENT OF WORK under Title III, reads in part as follows:

5. The title to all work under this Title III, shall be in the Government. Likewise, upon delivery at the site of the work, or at an approved storage site, title to all purchased materials, tools, machinery, equipment and supplies, for which the Contractor shall be entitled to be reimbursed under Title IV hereof, shall vest in the Government. The Government shall bear all risk incident to such ownership. These provisions as to title being vested in the Government shall not operate, however, to relieve the Contractor from any duties imposed upon it under the terms of this contract.

Article IV-A, section 1, of Title IV of the contract is as follows:

1. The Government shall bear all costs and expenses of every character and description incurred by the Contractor under Title III, when approved in advance or subsequently ratified by the Contracting Officer, which costs and expenses shall include but shall not be limited to the following items, to wit:

The contract further provides, in part and in effect, that the Government shall currently reimburse the contractor for expenditures made in accordance with article IV-A upon certification to and verification by the contracting officer of the original certified pay rolls for labor or original paid invoices for materials, or other evidence satisfactory to the contracting officer. The Government shall, at the request of the contractor and subject to the approval of Chief of Ordnance, advance to the contractor, without payment of interest, a sum not in excess of 30 per cent of the estimated cost of the work under Title III. When approximately 60 per cent of the estimated cost has been paid, a revised estimate of the cost shall be made by the contractor and if it appears that the estimated cost exceeds the amount of the original estimate and such revised estimate is approved by the Chief of Ordnance, the Government shall advance to the contractor without interest not to exceed 30 per cent of such excess. The contractor shall furnish a surety bond if prescribed by the Secretary of War in connection with the advances as security additional to that provided in the contract. Whenever the contractor has been paid reimbursements and advance payments equal to the full amount of the estimated cost, no additional payment on account of the work shall be made until the advance payments are expended, but if the total cost exceeds the amounts paid to the contractor, including advance payments, then, upon presentation of satisfactory evidence, the Government shall currently and promptly reimburse the contractor to the extent of such excess cost. If, upon termination of the contract for other than the fault of the contractor, there is due the Government from the contractor any sum advanced and not fully liquidated, the same shall be deducted from any payments due the contractor and any remaining balance returned to the Government after final audit by the Government. In the event of cancellation or termination of the contract because of the fault of the contractor, it shall return to the Government, upon demand, without set-off of any sum alleged to be due the contractor, the outstanding balance of any advance payment. If the unliquidated balance of any advance payment exceeds the amount necessary for the current needs of the contractor, upon demand of the Chief of Ordnance the excess shall be promptly returned to the Government and credited against the balance due the Government for advances previously made. All funds received as advance payments, together with all funds received as reimbursements for the cost of work under article IV-B, shall be deposited in a special bank account or accounts separate from the contractor's general or other funds. The special account or accounts shall be so designated as to indicate clearly to the bank their special character and purpose and shall be used by the contractor exclusively as a revolving fund for carrying out the purposes of the contract and not for its general business. Balances in such accounts shall at all times secure the repayment of the advances and the Government shall have a lien upon the balances superior to any lien of the bank upon the accounts by virtue of assignment to it of such contract or otherwise. The contracting officer shall be afforded proper facilities for inspection and audit of the special bank account or accounts. No payment for services in advance or for materials or supplies in advance of delivery at site of work or storage out of sums previously advanced to the contractor shall be made by it to any third party without the prior written approval of the contracting officer.

The status of the contractor under the contract, in the performance of its work under the contract, was that of an independent contractor and in nowise an agent of the Government.

Under the contract the Government had the right to terminate the contract upon the contractor's refusal, neglect, or failure to prosecute the work with promptness and diligence, or upon default in performance, or if conditions arose which made it advisable or necessary in the interest of the Government to cease work under the contract. If the contract was terminated due to the fault of the contractor, the contracting officer had the right to enter the premises and take possession of all manufacturing facilities, materials, work finished or in process, and supplies, title to which had been acquired by the Government under the contract. Upon termination of the contract, full and complete settlement of all claims of the contractor arising out of the contract were to be made as follows:

(a) The Government shall assume and become liable for all obligations, commitments and claims that the Contractor may have theretofore in good faith undertaken or incurred in connection with the work under Title III and in accordance with the provisions of said Title; and the Contractor shall as a condition of receiving the payment mentioned in this Article, execute and deliver all such papers and take all such steps as the Contracting Officer may require for the purpose of fully vesting in the Government the rights of the Contractor under such obligations or commitments.

(b) The Government shall reimburse the Contractor for all expenditures made in accordance with Title IV, not previously reimbursed, and except as otherwise provided in this contract shall pay to the Contractor all fees and lump-sum payments which have accrued at the date of termination.

(c) If this contract is terminated for the convenience of the Government, the Government shall reimburse the Contractor for such further expenditures after the date of termination for the protection of Government property and for accounting services in connection with the settlement of this contract and other expenses incident thereto as the Contracting Officer may approve.

(d) The obligation of the Government to make any of the payments required by this contract, shall be subject to any unsettled claims for labor or material or any claim the Government may have against the Contractor under this contract.

Contract No. W— ORD— 481 was modified by supplemental contract No. W— ORD—481 Supp. 1, dated June 27, 1941, increasing capacity of plant covered by the original contract; by supplemental contract No. W— ORD— 481 Supp. 2, dated September 10, 1941, amending section 5 of article IV— C, Title IV, of original contract to provide more specifically for the making of payments in advance by the contractor to third parties; by supplemental contract No. W— ORD— 481 Supp. 3, dated January 26, 1942, increasing capacity of plant covered by the original contract as amended; and by Change Order No. 4, dated June 9, 1943, increasing capacity of plant covered by the original contract as amended by Supp. 1 and Supp. 3. The estimated cost and fixed fee under Title III were increased with increases in plant capacity.

The general procedure followed under Contract 481 was for the orders for purchases of materials, supplies, or equipment, or other articles incident to Title III of the contract to be prepared by Western and forwarded to the contracting officer's representative for prior approval. Upon approval of the purchase orders the goods were ordered and received and invoices therefor were paid out out of the special deposit accounts. These invoices were audited before payment by Ordnance Department personnel for review purposes. After payment by Western these invoices were compiled by Western into vouchers on Government Standard Voucher Form No. 1034 for ‘Services Other Than Personal‘ and were approved by the Ordnance Department and submitted to the Finance Officer, United States Army. The Finance Officer thereafter issued a check for the amount of the voucher, which check was in turn deposited by Western in the special deposit accounts. A monthly reconciliation between the Government records, the bank records, and Western's records was made by the field auditor of the Ordnance Department and forwarded to the Office, Chief of Ordnance, Washington, D.C., periodically.

By letter dated April 4, 1941, Western requested an advance of $4,950,000 under article IV-C of contract W— ORD— 481. Prior to this request purchase orders under the contract aggregated $10,544,089.44. Such commitments were incurred by Western with the approval of the contracting officer. Of such commitments, Western paid $315,134.86 out of its own funds and not out of funds in the special accounts in which advances were deposited, but was later reimbursed therefor by the Government. By letter dated October 20, 1941, Western requested an additional advance of $4,000,000. Upon approval of vouchers (Standard Form 1034-Rev.) therefor, the requested advances were paid to Western by check dated April 29, 1941, for $4,950,000 and check dated October 28, 1941, for $4,000,000.

On June 9, 1942, Western began repaying by check the advances received by it under contract No. W— ORD— 481, and by August 31, 1942, it had repaid the amount of $5,800,000. On September 1, 1942, the balance in the advance account under the contract was $3,150,000. Between September 1, 1942, and December 31, 1942, Western repaid by checks an additional $2,150,000. Reimbursement to the Government by check was made at the request of Western, in lieu of following the method of submitting reimbursement vouchers (Form 1034) to be applied against and in liquidation of the advance payments.

Winchester entered into a letter contract (No. DA W 478 ORD— 3) with The United States of America, acting through a certain contracting officer, for the production of a certain number of rounds of specified ball and tracer cartridges at a total contract price of $11,440,358. The contract was dated June 13, 1941, and was approved by direction of the Secretary of War on November 27, 1941.

Winchester entered into another letter contract (No. DA W 478 ORD— 40), dated June 21, 1941, with the Government for the manufacture of 750,000,000 rounds of specified cartridges at a total contract price of $32,940,000. This contract was approved at the direction of the Secretary of War on June 24, 1941.

Prior to the execution of the letter contract No. 478 ORD— 40, petitioner submitted to the Chief of Ordnance, War Department, a so-called letter of quotation dated June 19, 1941. This letter quoted a price on 750,000,000 rounds of certain ball cartridges at $45.92 per thousand, or an aggregate price of $32,940,000, and stated, among other things, that the quotation was subject to certain enumerated conditions, one of which is as follows:

(2) That this company, at its request, be advanced by the contracting officer a sum equivalent to thirty per cent of the contract price of ammunition, to cover cost of raw materials, other out-of-pocket expenses and working capita.

Letter contract No. 478 ORD— 40, contains the following provisions:

* * * It is contemplated that this contract will be supplemented by a more formal contract between yourself and the United States of America substantially following United States Standard Contract Form No. 32 * * * .

It is mutually understood that the contract supplemental hereto will be substantially in accordance with negotiations pursuant to your letter of quotation of June 19, 1941 (File 0.0. 400.3295/8530— England).

The letter contract No. 478 ORD— 3 contains the same provisions except that the date of the letter of quotation is given as ‘May 16, 1941 (File 0.0 War Dept. 400.3295/8520).‘

Subsequently, negotiations were carried on between petitioner and the Government with regard to provisions to be incorporated in more formal contracts and in particular with regard to provisions relating to advance payments. Under date of September 2, 1941, counsel for petitioner transmitted to the legal advisor to the Chief of Ordnance, Washington, D.C., a draft of the advance payments provisions which it was desired to have incorporated in the formal contracts. This draft contained, among others, the following provisions:

ARTICLE 6. TERMINATION WHERE CONTRACTOR IS NOT AT FAULT.— If the Government terminates the principal contract or any amendment or supplement thereto before the completion of the contract, the Contractor shall, if the termination is for reasons other than the willful default of the Contractor, return to the Government all unexpended balances of the 30% advance then remaining, and the then market value of any unworked materials paid for from said advance. The Government shall accept and pay for (as hereinbefore provided) all finished ammunition which meets the specifications of the contract. Contractor will also liquidate as far as possible, all worked materials, so paid for, and from the proceeds of such liquidation it shall first reimburse itself for the cost of fabrication, including overhead plus the cost of liquidation, the remaining sum shall also be returned to the Government, but only to the extent necessary to liquidate the advance. Any balance of said 30% advance not liquidated as aforesaid, shall be considered expended and be unrecoverable.

In reply, the legal advisor to the Chief of Ordnance in a letter under date of September 6, 1941, stated in part as follows:

Generally speaking, I find little to complain of in the draft, since on the whole it embodies most of the basic principles in the standard form of advance clause, which has been used in thousands of War Department contracts, and I shall be happy to submit it to the proper officials of the Office of the Under Secretary of War for their cooperative consideration. I do have some misgivings about the last sentence in Article 6, of your draft, wherein discussing termination when the Contractor is not in default, you provide that you will return the unexpended balances of the 30% advance then remaining and the then market value of any unworked materials paid from said advance. You also undertake therein to liquidate so far as possible, work materials paid for from the Advance Account and turn in the proceeds of sale, less cost of fabrication, including overhead and the cost of liquidation to the credit of the account, but only to the extent necessary to liquidate the advance. Then you add, and this is what troubles me ‘any balance of said 30% advance not liquidated as aforesaid, shall be considered expended and be unrecoverable. ‘ This is not intelligible to me, since I view an advance as being in the nature of a loan to the Contractor. If it be a loan, it must be repaid and my concept of a loan does not contemplate that, when the contract is terminated for Government convenience, any balance due on the loan made by the Government to the Contractor shall be unrecoverable. * * *

To this letter petitioner's counsel, under date of September 8, 1941, replied, in part, as follows:

I am afraid that where your line of reasoning and mine come to a sharp divergence is in your thought that the advance, so far as these contracts are concerned, is or could in any way be construed as a ‘loan‘. These advances are for the express purpose of carrying these operations through to the point where the contractor begins to be remunerated. They will be used for labor and many items of supplies which will come under the head of ‘expended items‘. If the contract is carried through to completion the Government will receive every penny of the advance. If the contract is not carried through to completion, such part of the advance as is spent for expendable items will be lost forever.

The Winchester Repeating Arms Company Division of the Western Cartridge Company cannot, and will not, assume any part of this loss.

The supplemental contract prepared by petitioner's counsel was submitted to the Under Secretary of War, who under date of September 16, 1941, wrote petitioner, in part, as follows:

There has been forwarded by the Chief of Ordnance, for my consideration, a request for approval of advance payments totaling approximately $13,314,000, on Contracts Nos. DA W 478— ord— 3 and DA W 478— ord— 40, proposed to be entered into with the Western Cartridge Company, Winchester Repeating Arms Division * * * . With such request, there has been received a proposed form of supplemental agreement, prepared by your attorneys, with the intent that such agreement will provide the sole security for repayment of the requested advance payments. * * *

The Secretary of War is compelled by statute to require adequate security for advance payments. The form of agreement prepared by your attorneys departs in many matters of substance from the approved form generally prescribed as such security. It vitally impairs those features of the approved form which are the Government's sole protection. The approved form of agreement is extremely liberal to contractors. It was designed primarily for the purpose of expediting production and reducing to the simplest terms the legal requirement of adequate security. That form has been accepted without objection by scores of contractors, both large and small, some financially weak, others of unquestioned financial integrity. It cannot, therefore, be the policy of the War Department to make special exceptions, except that, in the case of companies whose financial strength and integrity is unquestioned, the provision of the approved form calling for liens on materials may be omitted, if considered onerous by the contracting officer from an administrative viewpoint, even though no surety bond is furnished.

It is understood that these contracts have been under negotiation for some months. No reason is seen why these negotiations may not be concluded in the immediate future by the use of an approved form of provisions, which is in every way fair to the contractor. I have, therefore, this day directed the Chief of Ordnance, in consummating negotiations in respect of advance payments on these contracts, to adhere to the approved form regularly used in such cases. * * *

Thereafter, the letter contract covering the 750,000,000 rounds of cartridges was supplemented by a more formal contract (contract No. DA W 478 ORD— 40, Supplement No. 1), covering supplies. A third contract (No. DA W 478 ORD—40, Supplement No. 2), for advance payments, was also executed. Both supplemental contracts were dated September 20, 1941, and approved by the direction of the Secretary of War on October 17, 1941.

The letter contract dated June 13, 1941, was also supplemented by more formal contracts Nos. DA W 478 ORD— 3, Supplement No. 1, covering supplies, and DA W 478 ORD— 3, Supplement No. 2, covering advance payments. Both supplemental contracts are dated November 8, 1941, and were approved by direction of the Secretary of War on November 27, 1941.

Supplement No. 1 to both contracts Nos. 478 ORD— 3 and ORD— 40, after describing the supplies to be furnished and delivered by the contractor, provides, among other things, for payment upon submission of properly certified invoices or vouchers of the prices stipulated for the articles delivered and accepted. Upon termination of the contract for the convenience of the Government, the contractor was to be paid the contract price of all supplies (including spare parts, drawings, information, and other things) called for in the contract which were completed and to which title had been received by the Government. The Government was also to compensate the contractor for the uncompleted portion of the contract by reimbursing it for all actual expenditures certified by it as having been made with respect to the uncompleted portion of the contract, including a proportionate share of the contractor's overhead attributable to the contract, and for all expenditures made with the prior written approval of the contracting officer in settling or discharging that portion of the contractor's outstanding obligations or commitments incurred or entered into with respect to the uncompleted portion of the contract. The contractor was also to be paid as a profit on the uncompleted portion of the contract a sum to be computed as provided in the contract. Subject to the approval of the contracting officer, the Government was to reimburse the contractor for expenditures made and costs incurred after the date of termination for the protection of Government property and for such other expenditures and costs as were necessary in connection with the settlement of the contract.

Article 29 of Supplement No. 1 to both contracts Nos. DA W 478 ORD— 3 and ORD— 40 covering ‘Advance Payments,‘ after referring to Supplement No. 2 executed at the same time whereby the Government agreed to advance 30 per cent of the principal contract price, provides that the obligation of the contractor to proceed with the work under Supplement No. 1 shall be contingent upon receiving advances in such amounts and at such times as may be necessary to enable the contractor to carry out the provisions of Supplement No. 1 without using any of its own credit or funds.

Supplement 2 to both contracts Nos. DA W 478 ORD— 3 and ORD— 40 provides, among other things, that, at the request of the contractor and subject to the approval of the Chief of Ordnance as to the necessity therefor, the Government shall advance to the contractor, without payment of interest, 30 per cent of the principal contract price, and that as a condition precedent to the making of any advance payment the contractor shall furnish such adequate security as the Secretary of War shall prescribe. Until all advances are liquidated, all advance payments under Supplement No. 2, together with 75 per cent of all cash payments under Supplement No. 1, shall be deposited in a special bank account or accounts, separate from the contractor's general or other funds. Such bank account or accounts shall be so designated as to indicate clearly to the bank their special character and purpose and used by the contractor exclusively as a revolving fund for carrying out the purposes of Supplement No. 2 and the principal contract and not for its other business. When required by the contracting officer, withdrawals from such accounts shall be made subject to his prior written approval. Any balance in such accounts shall secure the repayment of the advances made and the Government shall have a lien thereon to secure repayment of the advances, which lien shall be superior to any lien of the bank by virtue of assignment to it of the contract or otherwise. Upon completion of the principal contract or upon its termination for other than the fault of the contractor, the unliquidated balance of such advance payments, if any, shall be deducted from any payments otherwise due the contractor. If the sum due the contractor be insufficient to cover the balance, the deficiency shall be paid by the contractor in cash after final audit by the Government. If the contractor has reimbursed the Government, the money remaining in the special accounts shall become the property of the contractor. In the event of termination because of the fault of the contractor, the unliquidated balance in such special accounts, without set-off of any sum due the contractor, shall, upon demand, be returned to the Government. If the unobligated balance of the advance payments exceeds the amount necessary for the contractor's current needs, the excess shall, upon demand, be returned to the Government. The advance payments shall be liquidated by means of deductions from the unit contract price of completed articles delivered to and accepted by the Government of 30 per cent of the unit contract price. The contractor shall at all times afford the contracting officer proper facilities for inspection and audit of the contractor's accounts, including the special bank accounts.

The general procedure under the DA W 478 ORD— 3 and ORD— 40 contracts was that, when Winchester presented for payment invoices for ammunition shipped, the invoices were checked and verified in the Ordnance Department and a voucher on the Government Standard Form 1034 was prepared showing the total amount of the invoices to be paid, less 30 per cent, which was deducted as liquidation of advance payments. The vouchers were then set to the Finance Officer, United States Army, for payment, which officer issued a check for the net amount shown on the voucher, and 75 per cent of this reimbursement was deposited by Winchester in the special deposit accounts at the banks in accordance with the terms of the contracts. The fiscal information contained in the Form 1034 vouchers was then compiled by Winchester in a report which showed the unliquidated balance of the advance payments and the 30 per cent which was shown as a deduction on the voucher in order to reduce the balance of the advance payments. These reports were summarized periodically. The special accounts for deposit of advance payments were audited periodically by representatives of the Hartford (later Springfield) Ordnance District to verify that withdrawals from that account by Winchester were used only for purposes of the contract, viz., materials, labor, etc. A report showing such withdrawals and for what purpose used was also made monthly.

By letters dated January 26, 1942, and February 24, 1942, Winchester requested an ‘advance payment‘ of $874,535 on contract 478 ORD— 3, Supp. 2 and an ‘additional advance payment‘ of $555,304 on the same contract. Upon vouchers (Standard Form No. 1034-Rev.) covering the ‘first installment on account of advance payments‘ and ‘second installment on account of advance payments, ‘ respectively, the above requested amounts were paid to Winchester by checks dated February 7 and March 5, 1942. Pursuant to similar procedure, Winchester was paid requested advance payments by checks dated February 7 and March 6, 1942, of $4,574,976 and $2,883,172 on contract No. 478 ORD— 40, Supp. 2. The total amount of the advance payments received by Winchester on the two contracts was $8,887,987.

Repayments of the advance payments made to Winchester were also made during the year 1942. These repayments were made by deducting from the amounts vouchered for each invoice of goods sold sent to the Government by Winchester 30 per cent thereof for liquidation of the advance payments. The remaining 70 per cent of each invoice was paid to Winchester by Government check. During the period from September 1 through December 31, 1942, Winchester repaid the advance payments made to it in this manner to the extent of the decrease shown below.

+------------------------------------------------------------------------+ ¦Contract No. ¦Balance Aug. 31, 1942¦Balance Dec. 31, 1942¦Decrease ¦ +---------------+---------------------+---------------------+------------¦ ¦DA W 478 ORD-3 ¦$1,275,572.16 ¦$641,989.11 ¦$633,583.05 ¦ +---------------+---------------------+---------------------+------------¦ ¦DA W 478 ORD-40¦3,491,913.39 ¦1,620,801.87 ¦1,971,111.52¦ +---------------+---------------------+---------------------+------------¦ ¦Total ¦4,867,485.55 ¦2,262,790.98 ¦2,604,694.57¦ +------------------------------------------------------------------------+

The advance payments received by both Western and Winchester were kept in special checking accounts in banks in New York, Illinois, and Connecticut, separate and apart from other funds of Western and Winchester, respectively, in accordance with the terms of the contracts, and the funds so advanced were used only for the purposes mentioned in the respective contracts. In opening each of these accounts, petitioner specified that each account was to be a special account and each such account was designated by the number of the contract for which it was opened.

No promissory note was given by Western or Winchester relative to any of the advance payments received by them under contracts 481, 478— 3, and 478— 40. No surety bonds were required by the Government or given by Western or Winchester with respect to any of the advance payments received under such contracts. No interest was charged by the Government on the $8,950,000 advanced to Western under contract 481 or on the $8,887,987 advanced to Winchester under contracts 478 ORD— 3 and 478 ORD— 40. No interest was paid by any bank to Western or Winchester on the balances in the special deposit checking accounts wherein the advance payments were deposited pursuant to the provisions of such contracts.

In the balance sheets set forth in schedule L of petitioner's 1942 income tax return, the advances involved are shown under ‘Liabilities‘ as ‘Advances on U.S. Government and foreign contracts‘ as a separate item and not as a part of or an item under the headings: ‘Accounts payable,‘ ‘Accrued expenses,‘ or ‘Other liabilities.‘ In ‘Schedule C— Excess Profits Credit— Based on Invested Capital‘ of its excess profits tax return petitioner claimed or included no ‘borrowed capital.‘

In its excess profits tax return for 1942, the petitioner claimed a credit for debt retirement under section 783 of $2,175,331.25, being 40 per cent of $5,438,328.13, the reported net reduction in indebtedness. The amount of $5,438,328.13 includes the following items:

+-----------------------------------------------------------+ ¦ ¦Decrease in indebtedness from¦ +-----------------------------+-----------------------------¦ ¦ ¦Aug. 31 to Dec. 31, 1942 ¦ +-----------------------------+-----------------------------¦ ¦Winchester: ¦ ¦ +-----------------------------+-----------------------------¦ ¦Contract DA W 478-ORD-40 ¦$1,971,111.52 ¦ +-----------------------------+-----------------------------¦ ¦Contract DA W 478-ORD 3 ¦646,877.29 ¦ +-----------------------------+-----------------------------¦ ¦Total ¦2,617,988.81 ¦ +-----------------------------+-----------------------------¦ ¦Certain British contracts ¦670,339.32 ¦ +-----------------------------+-----------------------------¦ ¦Grand total, Winchester ¦3,288,328.13 ¦ +-----------------------------+-----------------------------¦ ¦Western: ¦ ¦ +-----------------------------+-----------------------------¦ ¦Contract ORD-481 ¦2,150,000.00 ¦ +-----------------------------+-----------------------------¦ ¦Total, Winchester and Western¦5,438,328.13 ¦ +-----------------------------------------------------------+

There is no issue in this proceeding with respect to the $670,339.32 repaid by Winchester to the British Government between September 1 and December 31, 1942, covering advances made by that Government under contracts between Winchester and the British Purchasing Commission. The Commissioner disallowed the claimed credit on the ground that the repayments of or credits against advances made under the contracts involved during 1942 did not constitute repayments of the principal of indebtedness as provided in section 783 of the Internal Revenue Code.

In its income tax return for 1942 the petitioner reported its total net income for declared value excess profits tax computation to be $55,477,010.13 and reported its adjusted net income to be $55,415,967.71. Petitioner's books of account and retained data in support of the return disclose that the net income of $55,477,010.13 was comprised of $28,178,120 from Winchester and $27,298,890.13 from all other sources.

Beginning at some time in the calendar year 1942 and continuing in the calendar year 1943, the representatives of petitioner had discussions with the representatives of the Price Adjustment Board of the War Department with regard to renegotiation of its war contracts pursuant to the Renegotiation Act. On or about December 1, 1943, petitioner was advised by the Price Adjustment Board that its renegotiable income included $30,685,000 of excessive profits realized under the contracts to be eliminated and refunded to the United States pursuant to the provision of the Renegotiation Act. Petitioner, under date of December 15, 1943, requested the internal revenue agent in charge at Springfield, Illinois, to advise it of the amount of the credit allowable for Federal income and excess profits taxes for 1942 as provided in section 3806 of the Internal Revenue Code, in order that the amount of credit so determined might be applied as a credit against the amount of profits eliminated by such renegotiation. Under date of December 18, 1943, the internal revenue agent in charge notified petitioner and also the Price Adjustment Board of the War Department that the amounts by which the Federal taxes for 1942 are decreased by reason of section 3806, by the elimination of $30,685,000, aggregate $24,560,208.49. On or before June 30, 1944, the petitioner paid to the United States the sum of $6,124,791.51. Thereafter, and on or about August 11, 1944, a ‘Renegotiation Agreement‘ was executed by and between petitioner and the United States of America with regard to the year 1942. Such agreement, in part, recites that as a result of renegotiation it has been found that $30,685,000 of the aggregate prices and fees of the contractor in effect under its enumerated contracts represents the amount of profits realized in 1942 under such contracts by the contractor which should be eliminated and refunded to the United States, and that such finding is ‘based upon the financial and other data, including the comparative statement of operating results before and after this adjustment‘ set forth in Exhibit C attached thereto, included herein by reference thereto. The agreement contains no reference to income taxes due or paid to the State of Connecticut.

Thereafter, the Commissioner examined petitioner's 1942 income and excess profits tax returns and determined its net income to be $25,794,976.08, resulting in an overassessment of income tax of $20,120.71. He determined the excess profits tax income to be $25,791,798.26 and the excess profits tax liability to be $18,782,302.86. He determined a deficiency of $2,997,824.72 in excess profits tax, as follows:

+-----------------------------------------------------------------------------+ ¦Excess profits tax liability ¦ ¦$18,782,302.86¦ +-----------------------------------------------+--------------+--------------¦ ¦Excess profits tax assessed: ¦ ¦ ¦ +-----------------------------------------------+--------------+--------------¦ ¦Original, June 1943 List, Account No. 9860 ¦$40,283,644.21¦ ¦ +-----------------------------------------------+--------------+--------------¦ ¦Less: Credit Section 3806 (b) of the Internal ¦24,499,166.07 ¦ ¦ ¦Revenue Code ¦ ¦ ¦ +-----------------------------------------------+--------------+--------------¦ ¦ ¦ ¦15,784,478.14 ¦ +-----------------------------------------------+--------------+--------------¦ ¦Deficiency in excess profits tax ¦ ¦2,997,824.72 ¦ +-----------------------------------------------------------------------------+

On December 29, 1944, and before the mailing of the notice of deficiency herein, petitioner executed and mailed to the internal revenue agent in charge, Springfield, Illinois, a waiver on Treasury Department Form 874 in which petitioner consented to the assessment of additional excess profits tax for 1942 in the amount of $1,119,594.43. Such waiver was received by the agent on December 30, 1944. On February 3, 1945, petitioner paid $1,099,473.72 tax, together with interest thereon in the amount of $123,690.79, to the collector of internal revenue for the eighth district, Springfield, Illinois, and at the same time claimed an offset of $20,120.71. The payment was acknowledged by the collector by a receipt therefor, dated February 3, 1945, sent to petitioner.

On November 27, 1945, petitioner executed a document, entitled ‘Waiver and Consent to Assessment,‘ with respect to the unpaid balance of $1,878,230.29 of the total asserted deficiency, as follows:

TO THE COMMISSIONER OF INTERNAL REVENUE

WASHINGTON, D.C.

On November 23, 1945, this taxpayer filed a petition with The Tax Court of the United States, therein appealing from the deficiency in excess profits tax asserted in Treasury Department letter dated Springfield, Illinois, August 30, 1945, and signed ‘Joseph D. Nunan, Jr., Commissioner, By Guss Jackson, Acting Internal Revenue Agent in Charge‘. Said petition bears Docket Number 9670 on the docket of the Tax Court.

The deficiency in excess profits tax asserted in said letter was $2,997,824.72. Of this amount, $1,119,594.43 was paid by taxpayer on February 1, 1945, (before the deficiency notice was mailed) pursuant to Form 874 executed December 29, 1944. The unpaid balance of the deficiency asserted is $1,878,230.29.

Pursuant to the provisions of Section 272(d) of the Internal Revenue Code, taxpayer hereby waives the restrictions on the assessment and collection of $1,878,230.29 of the deficiency asserted and requests immediate assessment and collection of said amount. This waiver and request for assessment and collection of said amount is made for the purpose of preventing the accruing of further interest on said amount, but is not an admission that taxpayer owes the tax. Taxpayer does not waive any rights which it has to prosecute to a final determination the aforesaid appeal to the Tax Court.

This waiver was sent to the Commissioner at Washington and was received in the Bureau of Internal Revenue on November 30, 1945. A signed copy was also sent to and received by the collector of internal revenue for the eighth district, Springfield, Illinois.

On December 3, 1945, petitioner paid the remaining balance of $1,878,230.29, together with interest thereon computed by the petitioner in the amount of $305,212.42, to the collector of internal revenue for the eighth district of Illinois. On December 3, 1945, the collector sent petitioner a receipt for this payment.

On March 13, 1945, petitioner filed a claim for refund of $20,120.71, the amount of the overassessment of 1942 income tax determined by the Commissioner, on Treasury Department Form 843 with the collector of internal revenue for the eighth district of Illinois, based upon adjustments in revenue agent's report dated December 29, 1944. Receipt of this claim was acknowledged by the collector on March 17, 1945.

On December 26, 1945, petitioner filed with the same collector a claim for refund on Treasury Department Form 843 covering the $1,878,230.29 paid on December 3, 1945, and interest thereon, on the ground that such amount represented a debt retirement credit to which petitioner was entitled in computing its excess profits tax for 1942.

In its Federal income tax return for 1942, petitioner included in the deduction for taxes an item of $580,000 for accrued State of Connecticut income tax. On or about June 12, 1943, petitioner filed with the Tax Commissioner at Hartford, Connecticut, its state income tax return for 1942, which disclosed a tax liability of $562,213.71, which was paid in full by payments made on or about March 27, 1943, and June 12, 1943. In a statement attached to that return, it is stated that petitioner did not follow the method of allocation and apportionment prescribed in sections 5 and 7 of the Corporation Business Act of 1935 for a taxpayer having a trade or business carried on partly within and partly without the State of Connecticut, for the reason that such formulae prescribed in such sections result in unjustly taxing a greater portion of its business than is reasonably attributable to the State of Connecticut, but that it computed its tax on a separate accounting basis as if Winchester were operating as a separate corporation instead of being an operating division of Western. In another statement attached to such return it is stated that negotiations were pending with the Price Adjustment Board of the War Department in reference to possible refunds, that such refunds were not reflected in the state income tax return, and that petitioner reserved the right to make such amended returns necessary or desirable in giving effect to any changes in the tax data submitted with the return.

On or about September 29, 1944, petitioner filed an amended income tax return with the Tax Commissioner of Connecticut and therein represented that by reason of renegotiation of its 1942 income with the Price Adjustment Board of the War Department petitioner's income attributable to Winchester had been overstated by $16,077,852.10 in its final state income tax return and the state income tax had been overpaid accordingly. On or about September 29, 1944, petitioner also filed with the State Tax Commissioner at Hartford, Connecticut, its claim for refund of the overpayment in the amount of $320,738.30. In response to the question contained in the claim for refund, as follows:

The taxpayer has— has not— received from or been allowed by the United States Government, or any agency thereof, a credit or benefit, as a deduction or otherwise, for or by reason of such overpayment.

the following statement was made:

(a) In it's (sic) determination of the amount of profits to be eliminated and refunded to the United States Government, the Price Adjustment Board has not informed this company as to which factors, or to what extent such factors, entered into its final determination. The Board refused to disclose such details, and insofar as the year 1942 is concerned, cannot be forced to do so. It may be presumed that, in the interest of consistency, it followed the same procedures as are now published in ‘Renegotiation Regulations for Fiscal Years Ending After June 30, 1943‘ (Paragraph 389) which allows as a credit the reduced recomputed State taxes based on income but does not allow the larger amount of such State taxes originally paid.

In the notice of deficiency herein and statement attached thereto, the Commissioner allowed a deduction of $572,876.13 for accrued State of Connecticut income tax. That amount was determined as follows, viz: Net income per return was reduced $30,685,000 in the aggregate for the renegotiation settlement, and a net increase of $1,002,965.95 was made for sundry other adjustments, showing a revised net income of $25,794,976.08. The net increase of $1,002,965.95 was comprised of a net increase of $534,802.26 in the income of Winchester and a net increase of $468,163.69 in the income from all other sources. The revised net income of Winchester before renegotiation was determined to be $28,712,922.26. The accrued State of Connecticut income tax due on $28,712,922.26 when correctly computed amounts to $572,876.13. By affirmative allegations the Commissioner now claims that the allowed deduction for accrued State of Connecticut income tax was overstated in the deficiency notice by not less than $318,629.08.

In a letter under date of June 1, 1945, the Tax Commissioner of Connecticut, after referring to an examination by the Tax Department at petitioner's New Haven plant in connection with its claim for a refund because of renegotiation for the year 1942 and also in connection with its 1943 return, wrote petitioner as follows:

You will recall that we requested previously that you file with this office copies of your federal returns based on the entire operations of your company. We believe without the benefit of the information contained in your federal returns, this department should withhold any refund whether based upon renegotiation or otherwise. Therefore, we suggest that you arrange to furnish copies of the federal returns for the years 1940 through 1943.

We also request that you furnish copies of any reports of federal field examinations covering any prior years affecting the Connecticut tax.

By letter dated November 12, 1947, the Deputy Tax Commissioner of the State of Connecticut advised petitioner, in part, as follows:

Recently we received an inquiry from the Treasury Department, Bureau of Internal Revenue, Chicago Division, Technical Staff inquiring as to the status of your claim for refund for the year of 1942. This department has requested you to file amended State tax returns for the years 1939 to 1944 inclusive, reflecting the total overall net income of the corporation and schedules supporting the proper allocation and apportionment of such total overall income. We have also requested you to furnish this department with copies of Federal tax returns for the years of 1939 to 1941 inclusive but to date you have failed to furnish any of these documents. You have continued to file your Connecticut tax returns on a separate accounting basis reflecting the net income of the Winchester Repeating Arms Division only.

The Connecticut statutes provide that corporations shall file their tax returns reflecting the total corporate overall income to be allocated and apportioned in accordance with the statute. This department cannot complete the processing of the tax refunds pending until you have furnished the amended returns and other data requested and an examination has been conducted by representatives of this department for the years 1939 to date.

By letter dated November 13, 1947, the Deputy Tax Commissioner notified the Bureau of Internal Revenue, Chicago, that petitioner's claim for refund of $320,738.30 was being held in the files of the Department pending receipt of notice of final determination of the taxable net income by the Bureau of Internal Revenue, and that:

* * * The Connecticut statutes do not permit this department to grant any refund resulting from renegotiation for calendar or fiscal years ending prior to June 30, 1943, until copy of the results of an examination by the Bureau of Internal Revenue has been received by this department. Upon receipt of this report we shall proceed with the processing of this claim.

OPINION.

VAN FOSSAN, Judge:

The first question to be considered is whether the repayments in 1942, of $2,150,000 on contract No. W— ORD— 481, $633,583.05 on contract No. 478 ORD—3, and $1,971,111.52 on contract No. 478 ORD— 40, of moneys received by petitioner from the Government under the respective contracts entitle it to a credit for debt retirement under section 783 of the Internal Revenue Code. The determination of this question is dependent upon whether the advance payments constituted an ‘indebtedness‘ within the meaning of section 783(d), which is as follows:

(d) DEFINITION OF INDEBTEDNESS.— For the purposes of this section the term ‘indebtedness‘ means any indebtedness of the taxpayer or for which the taxpayer is liable evidenced by a bond, note, debenture, bill of exchange, certificate, or other evidence of indebtedness, mortgage or deed of trust.

A similar question was considered in Gould & Eberhardt, Inc., 9 T.C. 455. In that case the taxpayer obtained from Defense Plant Corporation, an instrumentality of the United States, six purchase orders for an equipment pool of machine tools. Pursuant to the terms of the orders, Defense Plant Corporation advanced to taxpayer 30 per cent of the total purchase price. Upon sale of the tools to substituted purchasers taxpayer returned the advances to Defense Plant Corporation. It claimed that the advances constituted borrowed capital for the purpose of computing its excess profits credit and it also claimed a credit for debt retirement on the ground that the repayments of the advances constituted a reduction of indebtedness. This Court held that the advance payments did not constitute an indebtedness within the meaning of section 719(a)(1) and that the repayment thereof did not constitute a reduction of indebtedness within the meaning of section 783(d).

In seeking to distinguish Gould & Eberhardt, Inc., supra, petitioner states on brief, in part, as follows:

The Court in deciding that case followed the Canister (7 T.C. 967) and West Construction Co. (7 T.C. 974) decisions and held that no indebtedness had been shown under Sec. 719. The Court then concluded by holding (what necessarily followed) that no indebtedness had been shown under Sec. 783. A review of the record in that case, however, shows no evidence, such as is found herein, to the effect that the parties intended the advances to be loans or indebtedness * * * .

Herein the petitioner did not claim or report the advance payments received by it as borrowed capital. While its action in this respect is not determinative, it does indicate that petitioner did not regard the advances as ‘borrowed capital,‘ i.e., as ‘outstanding indebtedness‘ under section 719(a)(1).

With respect to contract No. W— ORD— 481, there is no evidence to the effect that the parties intended the advance payments to be loans to or indebtedness of the petitioner. Negotiations between petitioner's counsel and the legal advisor to the Chief of Ordnance, claimed by petitioner as showing such intendment, pertained only to contracts Nos. DA W 478 ORD— 3 and ORD— 40. Counsel for petitioner did not regard the advance payments as loans to or indebtedness of petitioner. On the contrary, in his reply to the legal advisor to the Chief of Ordnance, who had stated that he viewed an advance as being ‘in the nature of a loan,‘ petitioner's counsel stated:

I am afraid that where your line of reasoning and mine come to a sharp divergence is in your thought that the advance, so far as these contracts are concerned, is or could in any way be construed as a ‘loan‘. These advances are for the express purpose of carrying these operations through to the point where the contractor begins to be remunerated. * * *

The discussion of counsel related to the provision in the form of Government contract requiring the payment to the Government upon termination of the contract of the unliquidated balance of advance payments, if any, in the special bank account. This provision was required as security to the Government for the advance payments. Upon termination of the contract the purpose for which the advances were made ceased. The purpose was to finance the purchase by the contractor of materials required for the performance of the contract and to reimburse the contractor for pay rolls and other expenses for which otherwise the contractor would have had to borrow money for the purpose of the contract. With the termination of the contract operations thereunder ceased. The contractor was amply protected as to payment. Under the principal contract the Government agreed to pay the contractor the contract price for all completed supplies and also to reimburse him for all expenditures made, including overhead, as well as for outstanding obligations or commitments which had been incurred, with respect to the uncompleted portion of the contract. In addition, he was to receive a sum, as a profit on the uncompleted portion, computed as provided in the contract.

Here, as in Gould & Eberhardt, Inc., supra, the advances were payments against the purchase or contract price. Under the contracts liquidation of any advance payment was made by means of deductions of 30 per cent of the contract price of completed articles delivered. Upon termination or completion of the contract, the unliquidated balance of advance payments, if any, was deductible from payments otherwise due the contractor. The contractor was required to repay to the Government any unliquidated balance of advance payments only in the event the sum due the contractor was insufficient to cover such balance, and then only to the extent of the excess over the amount due the contractor. This amounts at most to a requirement of a return of an overpayment of the purchase or contract price.

Moreover, article 4 of Supplement No. 2 of both contracts Nos. 478— ORD—3 and ORD— 40 provides that if and when the contractor has reimbursed the Government in full for the advance payments any money remaining in the special bank account or accounts ‘shall become the property of the‘ contractor. Thus the moneys in the special bank accounts were not considered by the parties as the property of the contractor until full reimbursement by way of credit against invoices of the advance payments to the Government.

What was stated in Canister Co., 7 T.C. 967; affd. (CCA— 3), 164 Fed. (2) 579 (certiorari denied, 333 U.S. 874), is equally apposite herein, as follows:

The contracts in question called for the payment of prices by the Government for articles delivered by the contractor. The contractor's obligation was to make and deliver the goods. The Government's obligation was to pay money for the goods, and that obligation included an agreement by the Government to pay not more than 30 per cent of the total contract price in advance. By the terms of the contract the payments with which we are concerned were advance payments under the contract, and not loans.

The Western contract with respect to which the advance payments were made was a cost-plus-a-fixed-fee contract. By it the Government was obligated to pay a fixed fee for services and to reimburse Western for the cost of certain equipment and installation thereof in the St. Louis Ordnance plant. The Government was obligated to advance, at the request of Western, not to exceed 30 per cent of the cost of the work and equipment, title to which was to vest in the Government and it assuming all risk incident to ownership. When the reimbursements and advance payments equaled the cost, no further reimbursements to Western were required to be made by the Government. Thereafter reimbursement vouchers were applied in liquidation of the advance payments. However, the contractor could, as Western did, pay the advances by check instead of following the above procedure. Clearly, under this contract, the advance payments were advance payments as designated and not loans. The advance payments under the three contracts as supplemented, therefore, did not constitute an indebtedness of petitioner under section 783(d). In that view it is not necessary to determine whether the contract and request for advance payments, voucher, and acknowledgment of receipt thereof constituted, as argued by petitioner, a ‘certificate, or other evidence of indebtedness ‘ under section 783(d). Petitioner is not entitled to the claimed credit for debt retirement under section 783.

The next issue to be considered arose out of affirmative allegations of the respondent. In computing the deficiency herein the Commissioner allowed a deduction of $572,876.13 for accrued State of Connecticut income taxes for 1942. However, he now claims that the allowance of the deduction in that amount was erroneous in view of the renegotiation agreement and other adjustments and that the amount allowed was overstated by not less than $318,629.08.

The petitioner contends that its tax liability for 1942 is determinable on the facts as they existed on December 31, 1942, that the renegotiation agreement was not signed until 1944, that adjustment of its state income tax liability is still pending and it is questionable whether it will receive a refund, and that any adjustment thereof should be reflected in the taxable year when made.

The petitioner paid Connecticut income tax in the amount of $562,213.71 as disclosed by its 1942 state income tax return. In such return the income attributable to doing business in Connecticut was reported on a separate basis as if Winchester was operating on a separate basis instead of following the usual method of allocation based on the total over-all net income of petitioner. In such return petitioner also reserved the right to file an amended return upon completion of pending renegotiation of its income due to Government contracts. After the renegotiation agreement was signed petitioner, in September 1944, filed an amended state income tax return wherein it represented that its income attributable to Winchester had been overstated by $16,077,852.10. It also filed a claim for refund in the amount of $320,738.30. No action has been taken by the state tax authorities upon petitioner's claim for refund or with respect to the method of allocation of its income attributable to Winchester. Action will not be taken until receipt of notice of final determination of the taxable net income of petitioner for Federal income tax purposes.

In Chestnut Securities Co. v. United States, 62 Fed.Supp. 574, it is stated as follows:

* * * One is not entitled to accrue a debt or other liability which is asserted against him but which he disputes and litigates, until the litigation is concluded. But if a liability is asserted against him and he pays it, though under protest, and though he promptly begins litigation to get the money back, the status of the liability is that it has been discharged by payment. It is hardly conceivable that a liability asserted against him, which he has discharged by payment, has not yet ‘accrued‘ within the meaning of the tax laws and the terminology of accounting. Accrual, from the debtor's standpoint, precedes payment, and does not survive it.

In that case the taxpayer in 1940 paid additional income taxes for the years 1936, 1937, and 1938 asserted by the Oklahoma Tax Commission, plus interest, and at the same time gave notice of its intention to sue for their recovery. Suit was instituted. A trial was had and judgment entered in favor of the tax commission. Taxpayer appealed and in January 1942 the Circuit Court of Appeals for the Tenth Circuit affirmed the judgment of the District Court. The Supreme Court of the United States denied certiorari on April 13, 1942. In its 1940 Federal income tax return, taxpayer deducted the Oklahoma additional income taxes paid for 1936, 1937, and 1938, which deduction was disallowed. On May 29, 1942, a deficiency notice was addressed to the taxpayer. The taxpayer paid the additional income tax therein asserted, plus interest, and on December 27, 1942, filed a claim for refund, claiming therein that the $5,564.03 Oklahoma income tax and the $577.38 interest thereon paid to the State of Oklahoma during 1940 were proper deductions in computing its taxable income for 1940.

In our opinion, the rule of the above case is applicable herein. It is in accord with G.C.M. 25298, C.B. 1947-2, p. 39, wherein it is stated, in part, as follows:

As to contested deficiencies of tax which have been paid to the taxing authorities, though the contest of liability is continued by the taxpayer by the filing of a claim for refund and a suit in court for the recovery thereof this office is of the opinion that such deficiencies must be held to be deductible not later than the time of payment. (See Chestnut Securities Co. v. United States, 62 Fed.Supp. 574). The accrual basis of accounting for liability items relates to deductibility of items which are unpaid. (Cf. Dixie Pine Products Co. v. Commissioner, supra.) (320 U.S. 516.)

See also Gibson Products Co., 8 T.C. 654.

The petitioner is entitled to the deduction for Connecticut income taxes for 1942, but only in the amount paid.

In its assignment of errors on the part of the Commissioner, the petitioner alleged that in arriving at the deficiency in excess profits tax of $2,997,824.72, he had erred in failing to give petitioner a credit for a payment of $1,119,594.43 made by petitioner on February 1, 1945, prior to the date on which the deficiency notice was mailed. The amount of $1,119,594.43 consists of cash of $1,099,473.72 and off-set of $20,120.71, overassessment of income tax. This was denied by the respondent. However, respondent admitted in his answer that on December 29, 1944, petitioner executed Treasury Department Form 874 and therein consented to the assessment and collection of an additional excess profits tax of $1,119,594.43, that on or about February 3, 1945, petitioner paid to the collector at Springfield, Illinois, additional excess profits tax of $1,099,473.72 and $123,690.79 interest, and that respondent had not given credit for the payment in arriving at the deficiency in excess profits tax. In his reply brief, respondent states as follows:

The additional tax covered by the Form 874 and the deposit with the Collector prior to issuance of the statutory notice have since been assessed and the petitioner will have due credit therefor, as well as for payments made since the deficiency notice was mailed in the computation under Rule 50. There is nothing for the Court to decide at this time.

The respondent's statement disposes of this issue.

Decision will be entered under Rule 50.