Cartex Mills, Inc. v. Commissioner

*894 This proceeding involves deficiencies in petitioner's income tax and excess profits tax liability for the year 1935 determined*935 by respondent in the amounts of $3,082.53 and $1,120.92, respectively. That part of these deficiencies is in issue here which arises by reason of respondent's disallowance of deductions from gross income taken by petitioner for the taxable year with respect to processing taxes imposed under the Agricultural Adjustment Act.

Petitioner not only contests the deficiency determined, but also claims a refund for alleged overpayments in the amounts of $624.83 income taxes and $41.13 excess profits taxes, basing this claim on the contention that processing taxes accrued by it in 1934 and deducted by it for that year, but not paid until 1935 should have been deducted in the latter year.

FINDINGS OF FACT.

All of the facts have been stipulated by the parties and we adopt such stipulation as our findings herein.

A brief statement of the material facts is as follows:

Petitioner is a corporation, with its principal office at Salisbury, North Carolina, and was engaged in the manufacture of cotton yarn and the processing of cotton into yarn during the years the Agricultural Adjustment Act was in effect. Under the provisions of the Agricultural Adjustment Act (declared unconstitutional*936 by the Supreme Court on January 6, 1936) there was imposed upon petitioner a tax of 4.2 cents for every pound of cotton processed. Petitioner *895 paid processing taxes on cotton processed up to, and including March 1935. Processing taxes imposed and paid with respect to processing during January, February, and March, 1935, amounted to $8,392.29. In July 1935 petitioner filed a bill to enjoin the collection of said processing taxes, and in September 1935 a temporary injunction was granted by the United States District Court for the Middle District of North Carolina. In its decree the District Court waived the usual requirement that processing taxes imposed be impounded or placed in escrow as they became due, and in lieu thereof, allowed the collector to file notices of lien on petitioner's property in order to secure the payment of processing taxes becoming due. The temporary injunction was made permanent and petitioner's property released from lien in January 1936, after the decision of the United States Supreme Court in *937 United States v. Butler,297 U.S. 1, declaring the Agricultural Adjustment Act unconstitutional.

In August 1935 petitioner inserted in all its sales contracts the so-called Charlotte 90-day agreement, which provided as follows:

If and when, for any reason, sellers liability for processing taxes levied under the AAA as heretofore and hereafter amended is increased, decreased, or terminated, or such taxes shall be invalidated by final decision of the U.S. Supreme Court, prices on any undelivered portion of this contract are subject to adjustment at a rate per pound computed on the basis of the conversion factors set up by Treasury Department Decision 4433, approved May 10th, 1934.

In addition, the seller will credit on the purchaser's account the amount, computed on the basis of such conversion factors, of any such tax which, by reason of such invalidity, shall have been refunded to the seller or the seller shall have been relieved from paying, with respect to any delivered portion of this contract, invoiced within ninety days prior to such determination of invalidity, provided the buyer shall only be entitled to such credits with respect to such delivered*938 portions, held on floor stocks, as to which direct refunds from the Government are not recoverable by the holders of such stocks.

When the Supreme Court invalidated the tax on January 6, 1936, the petitioner was bound by the terms of the Charlotte agreement to refund to its vendees an amount equal to the tax on all goods delivered to the vendees during the 90-day period prior to January 6, 1936. The tax on the goods manufactured and delivered during 1935 with respect to which a refund was due amounted to $14,026.08. This amount was refunded to vendees by petitioner in 1936.

During all the years in question petitioner kept its books and filed its returns on an accrual basis. Upon this basis petitioner accrued processing taxes in the year of imposition, regardless of when they were paid. Processing taxes in the amount of $8,919.51 imposed with respect to processing during 1934 were accrued in that year and deducted on petitioner's 1934 income tax return, even though payment was not made until 1935. Petitioner had a net loss for the year 1934 of $39,974.42. Processing taxes imposed during the year 1935 but not *896 paid, in the amount of $49,805.41, were accrued by*939 petitioner and deducted on its 1935 income tax return. Included in this amount were taxes in the amount of $14,026.08 with respect to which petitioner made refunds to its vendees, and to which reference has been made heretofore. It is this latter amount which petitioner now claims is properly accruable and deductible by it for the year 1935, accruable, not as taxes (see J. A. Dougherty's Sons, Inc.,42 B.T.A. 892), but as obligations incurred by it under the so-called Charlotte 90-day agreement, set out above.

Petitioner has filed a claim for refund of all processing taxes paid. This claim was filed under the provisions of Title VII of the Revenue Act of 1936 which require a claimant to prove that the burden of the tax was not shifted before a refund can be made. No part of the processing taxes paid has been refunded to petitioner.

The respondent has refused to allow as deductions or eliminations from petitioner's 1935 income any of the amounts described above.

OPINION.

KERN: Respondent has conceded error in disallowing the deduction claimed by petitioner from its gross income for the year 1935 in the amount of $8,392.29 representing processing taxes*940 imposed in 1935 and paid in 1935. Therefore, there are but two questions remaining for our decision.

The first question is whether taxes in the amount of $8,919.5 accrued in 1934 by petitioner, which was using the accrual method of accounting, but not paid by it until 1935, are properly deductible by it in the latter year, the taxes having been imposed by an act of Congress which was declared unconstitutional by the Supreme Court in 1936.

This question involves the vexed problem of the correct treatment of deductions taken by reason of taxes paid under unconstitutional taxing statutes and void regulations, and, conversely, the treatment of refunds received by taxpayers in later years on account of such payments. For a general, although already outdated discussion of this problem, see Robert C. Brown, The Treatment for Federal Income Tax Purposes of Errors in the Deduction of Other Taxes, 86 U. of Pa. L.R. 385.

In three relatively early cases, the Board, reasoning from an opinion of the Supreme Court in Norton v. Shelby County,118 U.S. 425, which dealt with an entirely unrelated subject, reached a conclusion that taxes paid under a law later declared*941 to be unconstitutional could not be considered as a legal deduction from gross income in the year in which they were paid, and that, therefore, a refund of such taxes in a later *897 year would not constitute taxable income in such year of refund. Inland Products Co.,10 B.T.A. 235; affd., 31 Fed.(2d) 867; Philip C. Brown,10 B.T.A. 1122; Lehigh Valley Coal Sales Co.,15 B.T.A. 1401. For a criticism of two of these cases see Estate of William H. Block,39 B.T.A. 338, 341. In each of these three cases the taxable year considered by the Board was the year in which the taxes were paid, and prior to the determination of deficiency there had been refunds of these taxes to the taxpayer.

Later, in the case of E. L. Bruce Co.,19 B.T.A. 777, the Board cited the three earlier cases of the Board, together with Norton v. Shelby County, supra, for the general proposition that taxes imposed by an unconstitutional statute could not be deducted from gross income either in the year of accrual or of payment, but stressed the fact that in those earlier Board cases the taxpayers*942 had received refunds of the taxes so paid prior to the determination of the deficiency. Our decision in that case was that the payment was made in settlement of a suit brought by the state for the collection of taxes, was necessary in order to prevent protracted litigation and permit the taxpayer to proceed with its usual business, and was deductible as a loss or an ordinary and necessary expense.

Some five years later, in the case of Charles F. Fawsett,30 B.T.A. 908, we again considered the question of the deductibility of taxes paid under an unconstitutional statute and there held that where amounts are demanded and paid as taxes even under an unconstitutional statute and recovery of such amounts is impossible by reason of the limitation period prescribed by the statute, the amounts are deductible as "taxes paid." In that case we distinguished Philip C. Brown, supra,Inland Products Co., supra, and Lehigh Valley Coal Sales Co., supra, because of the fact that in those cases "the amounts illegally exacted were refunded to the taxpayers, and * * *, having been made whole, they were not in a position to claim deductions. *943 " No attempt was made to distinguish the decision of E. L. Bruce Co., supra, on this point, and, therefore, we must consider that part of the opinion in the latter case, to the effect that taxes paid or accrued under an unconstitutional statute can not be deducted as such, as dictum and no longer to be followed.

Our conclusion with regard to E. L. Bruce Co., supra, is substantiated by a reference to it in the recent case of Dixie Margarine Co.,38 B.T.A. 471, 475, as follows:

In E. L. Bruce Co.,19 B.T.A. 777, and Charles F. Fawsett,30 B.T.A. 908, we held that amounts paid as taxes under unconstitutional and void state statutes, where such amounts had not been later refunded and refunds were barred by limitations or otherwise, were allowable deductions in computing Federal income tax liability for the years in which paid * * *. Such amounts *898 have been held not to constitute allowable deductions from gross income for the year in which paid only in those cases where refund was received prior to the final determination of the tax liability for the year in which the refunded payment*944 was made. Inland Products Co.,10 B.T.A. 235; affd., 31 Fed.(2d) 867; Mary W. Leach,16 B.T.A. 781; affd., 50 Fed.(2d) 371; and compare Joseph V. Horn,23 B.T.A. 1131.

This quotation would seem to accurately state the rule now applied by us to the deduction of taxes imposed by unconstitutional statutes. The fundamental reason for this rule is well stated in Estate of William H. Block, supra, as follows: "Income tax liability must be determined for annual periods on the basis of facts as they existed in each period." (Italics supplied.) See also Central Loan & Investment Co.,39 B.T.A. 981. It has been frequently said that taxation is a practical matter. To state that an unconstitutional statute should be considered as void ab initio may be sound legal metaphysics and helpful in some circumstances, but, as the Supreme Court itself has said in a recent decision, it is a broad statement, with "must be taken with qualifications." *945 Chicot County Drainage District v. Baxter State Bank,308 U.S. 371. See also Anniston Manufacturing Co. v. Davis, 87 Fed.(2d) 773. To conclude, in an interpretation of the revenue acts, that substantial amounts paid pursuant to a taxing statute, vigorously enforced by the sovereign and not declared unconstitutional until a later year, are not "taxes paid or accrued within the taxable year" within the meaning of the revenue act would be, by way of understatement, highly impractical.

As to taxes paid pursuant to a statute later held to be unconstitutional, both petitioner and respondent seem to agree with the rule above stated, for it is conceded that the processing taxes accrued by the petitioner for the year 1935 and paid by it in that year are properly deductible. Respondent, however, contends that those taxes accrued by the petitioner in 1934 and not paid until 1935 are not deductible by it from its gross income for the latter year. Petitioner, on the other hand, takes the rather startling position that while taxes paid under an unconstitutional statute may be properly deducted, there may be no accrual of taxes under such a statute. *946 As authority for this position it relies on the dictum in E. L. Bruce Co., supra, which we have already discussed. A careful reading of this dictum indicates that if it were followed no deduction would be permitted either in the year of accrual or the year of payment. That dictum, however, as we have pointed out, no longer states the law as it is now understood. We know of no sound reason based upon theory or practice to limit the application of the present rule stated in the quotation from Dixie Margarine Co., supra, set out above, to cases where amounts were paid as taxes under unconstitutional *899 statutes and not apply it to cases where amounts were accrued as such taxes and later paid.

If, as petitioner contends, the taxes involved here were deductible by reason of the fact that no refunds have been made and that such refunds are impossible or improbable, they were properly deductible in the year in which they were accrued by petitioner, which was on the accrual basis. United States v. Anderson,269 U.S. 422; *947 Ernest M. Bull, Executor,7 B.T.A. 993; American Cigar Co.,21 B.T.A. 464; Central United National Bank,33 B.T.A. 588.

On this issue our decision is for respondent.

The remaining question is whether the Commissioner erred in disallowing as a deduction from the petitioner's gross income for 1935 or in failing to exclude from the gross income for that year an item of $14,026.08 representing processing taxes imposed on petitioner and accrued on its books in 1935, which it was under obligation to refund to its vendees in the event the Agricultural Adjustment Act was declared unconstitutional and which was refunded to its vendees in 1936 pursuant to agreements executed in 1935.

Upon this issue our decision is for petitioner, on the authority of Sanford Cotton Mills, Inc.,42 B.T.A. 190.

Reviewed by the Board.

Decision will be entered under Rule 50.