Jamaica Water Supply Co. v. Commissioner

*360 By his notice of deficiency respondent asserted deficiencies against petitioner as follows:

*1010 By amended answer respondent asserted an additional deficiency of $1,163.66 for the taxable year ended June 30, 1935, resulting from the inclusion in income of interest accrued on contested rentals. This action is not in controversy, petitioner having conceded its propriety.

On the errors charged by petitioner the following several issue are presented:

1. Whether respondent erred in including in petitioner's gross income for the fiscal year ended June 30, 1934, the sum of $575,000, representing $527,355 principal and $47,645 interest, received by petitioner on July 25, 1934, pursuant to settlement, in December 1933, of claims for hydrant service rendered to the city of New York during the years 1923 to 1928, inclusive.

2. Whether respondent erred in including in petitioner's gross income for the fiscal year ended June 30, 1934, $1,300 representing an adjustment to reserve for New York gross earnings tax which was credited to surplus on petitioner's books.

3. Whether respondent erred in disallowing a deduction in the sum of $3,499.68 as a loss sustained on the abandonment of certain equipment.

4. Whether respondent erred in including in petitioner's gross income*1011 for its taxable years ended June 30, 1934, and June 30, 1935, the sums of $400.89 and $1,174.18, respectively, which sums represented refunds of compensation insurance premiums applicable to and deducted in prior years.

5. Whether respondent erred in disallowing deductions of $1,583.18 and $1,670.90 for depreciation on the property contributed by consumers in the taxable years ended June 30, 1934, and June 30, 1935, respectively.

*361 FINDINGS OF FACT.

All of the stipulated facts are hereby found accordingly. Those facts hereinafter appearing which are not stipulated are otherwise found from the record.

Petitioner, a New York corporation, is engaged in supplying water for domestic and public purposes, including furnishing fire protection, to that part of the city of New York known as the County of Queens.

On December 21, 1908, petitioner had a contract with the city for fire hydrant service in the Borough of Queens at an agreed rental of $18 per hydrant per annum, which contract terminated on July 1, 1913. After the termination of the contract petitioner continued to supply the service at the same rate.

On April 29, 1919, petitioner advised the Department*1012 of Water Supply, Gas and Electricity that from January 1, 1919, it would charge the city of New York a rental of $45 per hydrant per annum.

Beginning June 30, 1919, petitioner regularly billed the city of New York at the annual rate of $45 per hydrant. The city paid for the service at the rate of $18 per hydrant, petitioner accepting such payments under protest. Petitioner thereafter filed claims with the city for the difference.

Petitioner's books showed its hydrant rental records were kept in two columns, one column recording the charge of $18 a year and the other a charge of $45 a year. Its journal entries were made on the basis of the $18 a year rate.

On October 22, 1929, petitioner brought action against the city to recover $822,330.42 plus interest, being the difference between the $18 rate and the $45 rate for the services rendered during 1919 to 1928, inclusive. In the answer filed by the city it denied that the $45 rate was the fair and reasonable one and alleged that the six-year statute of limitations barred the action. It also alleged the petitioner had accepted the payments under the $18 rate in full accord and satisfaction of all claims for services.

*1013 On December 10, 1929, the Commissioner of Water Supply, Gas and Electricity, after investigation, and on advice of its chief engineer that $45 per annum per hydrant was the fair and reasonable value for the service, fixed and established that rate, effective January 1, 1929.

On December 21, 1933, the city of New York made an offer to petitioner to allow judgment to be taken in the suit in the sum of $638,185.58, which amount equals the hydrant rental claims for the years 1923 to 1928, inclusive, being $527,355 plus interest of $110,830.58. Petitioner accepted this offer, and judgment was entered on December 22, 1933. By later agreement the interest was reduced *362 to $47,645. On July 25, 1934, petitioner received payment in satisfaction of the judgment in the sum of $575,000, being $527,355 principal plus interest of $47,645.

The entire cost of furnishing hydrant rental service for each of the years 1923 to 1928, inclusive, was charged to the years in which the service was rendered, and deductions therefor were claimed and allowed as deductions on petitioner's income tax returns filed for those years.

Since 1923, as well as for prior years, petitioner consistently*1014 maintained its books on an accrual basis and prepared and filed its Federal income tax returns on that basis. In its income tax returns for the taxable periods in which the bills to the city for the years 1923 to 1928, inclusive, were rendered, the claims against the city in excess of $18 per hydrant per annum were omitted, no reference being made thereto on the returns.

In computing petitioner's gross income for the year ended June 30, 1934, respondent included the sum of $575,000 received from the city in satisfaction of its judgment for hydrant service for the years 1923 to 1928, inclusive, and adjusted that net income for that year by deducting the interest accrued on the judgment for the year ended June 30, 1934, in the amount of $6,255.43, which petitioner had already reported as income in that year.

In his notices of deficiency respondent increased gross income for the fiscal years ended June 30, 1934 and 1935, in the respective amounts of $78,000.40 and $157,749.76, being the differences between the amounts billed for hydrant service in those years and the amounts paid. This inclusion is apparently not in issue, no allegation of error in this respect having been included*1015 in the petition.

Examination of petitioner's income tax returns for the fiscal years ended April [sic] 30, 1923, ¹ to April [sic] 30, 1929, 1 inclusive, were made by respondent, and final closing agreements were entered into for those years. Respondent accepted the return for 1928 as filed and allowed an overassessment of $7,986.27 for 1929. Respondent in effecting the above did not include in petitioner's income any part of the claims made by petitioner against the city in excess of the $18 rate, which amount was reported on its returns by petitioner.

On January 15, 1934, petitioner paid the State of New York the sum of $12,492.60 as a franchise tax based on gross earnings. It deducted this amount in its return for the taxable year ended June 30, 1934, as taxes paid. Petitioner maintained a reserve for New York State gross earnings tax for the fiscal year 1934, and as of June 30, 1934, a journal entry was made on its books of account "with respect to this reserve for the gross [earnings] tax."

*363 In its return for the taxable year ended June 30, 1934, petitioner deducted $3,499.68 as a loss on abandonment. *1016 This loss was not charged to the profit and loss account on petitioner's books, but was charged against depreciation reserve in accordance with the uniform system of accounts prescribed by the Public Service Commission of New York.

During the taxable years ended June 30, 1934, and June 30, 1935, petitioner received from an insurance company refunds of $400.89 and $1,174.18, respectively, representing adjustment of compensation insurance premiums paid during the respective preceding taxable years. These items, deduction of which had been allowed in prior years, were not included by petitioner as gross income in its returns for the applicable periods. Respondent has so included them in his notices of deficiency.

For the taxable years ended June 30, 1934, and June 30, 1935, respondent disallowed deductions in the amounts of $1,583.19 and $1,670.90 representing depreciation on "contributions for extensions."

OPINION.

Issue 1.

OPPER: Whether petitioner is taxable upon the contested income in the tax year in which the controversy concerning it was settled appears to depend upon whether that income was properly accruable at some previous time; for, if it was, respondent*1017 having expressly waived the defense of estoppel, there would be no reason for taxing it now. On the other hand, the income was unqualifiedly recognized as owing in the year before us. Accordingly, if it was not properly accruable in prior years there can be little doubt that it was then chargeable to petitioner.

The point of time when income becomes sufficiently definite and certain to be the proper subject of accrual is a question which has been the subject of extensive litigation. As a result, the principles involved have by now become reasonably clear and this proceeding appears to present a not particularly complicated subject for the application of such principles.

The income in question is the amount of rentals which petitioner sought to collect from the city of New York for water supplied to its hydrants during the years 1923-1928, inclusive. During all this time an annual rental of $18 per hydrant was accrued as income on petitioner's books, and apparently conceded by the city to be due. The difference between that amount and $45 per hydrant was claimed by petitioner and contested by the city. This difference remained the subject of controversy until December 1933, *1018 within the tax year before *364 us, when litigation involving it was settled for an amount which was actually received a few months later. It is the inclusion of this amount in petitioner's income for the year of settlement which it contests.

We think it clear that the disputed parts of the hydrant rentals were not properly accruable in the years when the services were performed. Not only the amount but the existence of liability was contingent and doubtful at that time. See Kentucky & Indiana Terminal Railroad Co.,19 B.T.A. 969; affd., 54 Fed.(2d) 738 (C.C.A., 6th Cir.); certiorari denied, 286 U.S. 557. The only amount concerning which there was no dispute was that which petitioner actually did accrue contemporaneously. With respect to all of the excess over that amount, the city of New York denied any liability whatever, so that it was possible that an adjudication of the controversy would result in no recovery by petitioner or in a recovery the amount of which might be anything between the undisputed liability of the city and the rental which petitioner claimed. Under these circumstances it seems clear that no proper basis*1019 for the accrual of any part of the contested rent existed prior to the time when the parties agreed upon a settlement of the pending litigation. United States v. Anderson,269 U.S. 422; Lucas v. American Code Co.,280 U.S. 445. Of course, the same applies to the interest on the disputed rentals. McGuirl, Inc. v. Commissioner, 74 Fed.(2d) 729 (C.C.A., 2d Cir.).

Petitioner relies principally upon the case of Brooklyn Union Gas Co., 22 B.T.A., 507; affd., 62 Fed.(2d) 505 (C.C.A., 2d Cir.). But the distinction from the present situation is readily apparent from the opinion of the Circuit Court of Appeals in that case. There the court took the view that the disputed amounts were paid or made available currently to the taxpayer, with the proviso that they be subject to return upon an adverse determination. The dissenting judge, it is true, was of the opinion that some of the payments did not fall into that category, but that merely emphasizes the basis upon which the court's decision rests. Since it was the liability to return which was contingent and not the right to receive, it was only*1020 the latter liability which could not be the subject of an accrual until it became definite. See Commissioner v. Thatcher & Son, 76 Fed.(2d) 900 (C.C.A., 2d Cir.). Here, of course, the situation is reversed. Petitioner did not receive payments of any amounts in excess of the rentals conceded by the city to be due. It had no liability to return any amounts and it was the receipt by petitioner and not the disbursement by it which was so uncertain as to preclude accrual.

Similarly, in Illinois Terminal Co.,5 B.T.A. 15, also relied upon by petitioner, the income in question, or substantially all of it, was *365 available to the taxpayer in the years when it was earned. Furthermore, while not actually accepted, its amount was readily ascertainable, at least with approximate correctness, and there was apparently no dispute as to liability. The opinion states (p. 22):

* * * The full amount of just compensation, as measured by the so-called standard return, was known both to the Government and to the taxpayer during all of the years 1918, 1919, and 1920, and all of that amount definitely accrued by virtue of the Federal Control Act of*1021 March 21, 1918, and that amount definitely accrued the absence of agreement no less than 90 per cent thereof, was payable to the taxpayer in convenient installments throughout that period. * * *

The complete dissimilarity between that situation and the one now before us, where the entire claim was in dispute and no possible method existed whereby the amount ultimately to be awarded could be even roughly approximated, calls for no further elaboration.

Petitioner assails the action taken by respondent on the ground that its income will be distorted as a result of the accrual in previous years of expenses attributable to the service supplied, so that income will be charged to it in the present year without the corresponding deductions. But that is a situation which is bound to occur where deductions are definite and ascertainable and receipts are indefinite and contingent. See Commissioner v. Thatcher & Son, supra.Moreover, there seems no way to avoid the conclusion that a determination in favor of petitioner would result in an equal or greater distortion of the previous year's income in its own favor. This would be attributable to the action of petitioner*1022 itself in failing to accrue the amounts in question as income in the previous years. It was, of course, justified in that action if its situation was that described in Kentucky & Indiana Terminal Railroad Co. v. Commissioner, supra:

* * * It did not place these items upon its books or return them as accrued income in the Federal Control years. This omission was not the result of oversight. It arose from the uncertainty petitioner entertained as to its duty to return the items for those years.

But, if so, that demonstrates that in the earlier years the items were so doubtful and uncertain that accrual would have been unjustified, and that only when that doubt and uncertainty was removed by settlement or payment would the inclusion in income be proper. Petitioner's own treatment of the disputed items in failing to accrue them on its books, or to include them in its return, is persuasive evidence of the correctness of respondent's position. See Moran v. Commissioner, 67 Fed.(2d) 601 (C.C.A., 1st Cir.); *1023 S. Rossin & Sons, Inc.,40 B.T.A. 1274.

Petitioner strenuously opposes the admission of evidence of the manner in which it treated these items on its tax returns for the earlier years. The question was raised by petitioner's objection to *366 the materiality of the stipulated evidence and by motion to strike, on both of which, pursuant to agreement of counsel, decision was reserved. We now rule that the evidence was admissible for the reason suggested in the foregoing comment. The treatment accorded by petitioner is material since it bears upon the frame of mind of its responsible officers contemporaneously with the disputed transactions and suggests the plausibility of the view that the amounts in question were too doubtful of collection to be treated as taxable income at that time. We see no reason to assume that the disposition of the matter for income tax purposes was erroneous. S. Rossin & Sons, Inc., supra.That this evidence might also bear upon the issue of estoppel if it were in the case does not militate against its materiality in other connections.

Finally, petitioner contends that respondent is guilty of an inconsistency*1024 in charging it with income in the years before us to the full extent of the rentals claimed. But it is by no means clear that the situation in the present years was the same as that involving the rentals prior to 1929. And, of course, the absence of evidence on this point must be judged in respondent's favor. Whether respondent is inconsistent is a matter we need not decide. For, if he was wrong with respect to the later rentals, that question is not in issue, and it seems to us he was clearly right in his treatment of the rentals relating to the earlier years.

On this issue respondent's determination is sustained.

Issue 2.

No facts relating to petitioner's method of handling the gross earnings tax reserve on its books are in evidence, nor does it appear whether petitioner, being on the accrual basis, accrued its liability for these taxes on the basis of estimated future amounts represented by the charges to reserve. It does appear that the payment made in January 1934 was for gross earnings tax for the year ended October 31, 1933. But whether or not that or any other amount was accrued as tax liability during that prior year is not shown. Respondent contends that, *1025 in fact, the disputed item constitutes the adjustment of a deduction claimed by petitioner for a prior year and, hence, that the transfer of the amount from reserve to surplus represents income made available to petitioner in the present year and that it is taxable as such. The facts, if they exist, which would be necessary to rebut the prima facie correctness of respondent's determination have not been produced. For that reason this issue must be determined in favor of respondent.

*367 Issues 3 and 5.

All of the evidence on these issues is contained in the following excerpts from the stipulation:

[Issue 3.] The loss of $3,499.68, claimed by the petitioner on its return as abandonment, was not charged to the profit and loss account on the books of the petitioner but was charged against depreciation reserve, in accordance with the uniform system of accounts described by the Public Service Commission of New York.

[Issue 5.] For the year 1934 the Commissioner disallowed depreciation claimed by the petitioner on its return in the amount of $1,583.19, which disallowance was arrived at as follows: [Here follow detailed computations showing the amount disallowed*1026 in the sum of $1,583.19.]

For the year 1935 the Commissioner disallowed depreciation claimed by the petitioner on its return in the amount of $1,670.90, which disallowance was arrived at as follows: [Here follow detailed computations showing the amount disallowed of $1,670.90.]

It seems manifest that the facts upon which a consideration of these issues could be predicated according to the principle of Illinois Pipe Line Co.,37 B.T.A. 1070, relied upon by the petitioner on the third issue, or of any other authority, have not been placed before us. Petitioner seeks to amplify the stipulation by reference to the deficiency letter. However, no authority exists for us to treat this as evidence of the facts contained therein or to use it to supply material otherwise absent from the record. Charles F. Ayer,7 B.T.A. 324; affd., 26 Fed.(2d) 547 (App. D.C.). Consequently, no factual basis is furnished for overruling respondent's determination and it must be sustained.

Issue 4.

Expenses paid or accrued in a prior year and properly deducted from income at that time which are subsequently adjusted and refunded are proper additions*1027 to income in the year of receipt. The cases claimed by petitioner to demonstrate a contrary view may be distinguished as were those in Estate of William H. Block,39 B.T.A. 338, 341; affd., 111 Fed.(2d) 60 (C.C.A., 7th Cir.); where the Board said:

* * * The holding in each of those cases was that the deduction was erroneously allowed in the first place and, since the year before the Board was that in which the original deduction was taken that original deduction was reduced by the later recovery. Those cases may be distinguishable upon the fact that there the original deduction was not properly allowed under the statute, whereas here the original deductions were proper. Furthermore, the solution given in those cases is an impractical one in many instances because the tax liability for the prior year had been closed before the recovery by the taxpayer of the amount originally claimed as a deduction.

*368 Income tax liability must be determined for annual periods on the basis of facts as they existed in each period. When recovery or some other event which is inconsistent with what has been done in the past occurs, adjustment must be made*1028 in reporting income for the year in which the change occurs. No other system would be practical in view of the statute of limitations, the obvious administrative difficulties involved, and the lack of finality in income tax liability, which would result. The foregoing principles, which have been established by the following cases, require that the refund here be included in the income of this estate for the year of recovery.

There is no claim here that the insurance premiums were not properly deducted in the previous years, and, particularly considering the petitioner's accrual basis, it is difficult to see how there could be grounds for any such claim.

On the authority of Estate of William H. Block, supra, and similar cases, respondent's determination that the refunds of insurance premiums previously paid and properly deducted were income when returned to petitioner was correct and must be approved.

Decision will be entered under Rule 50.