Globe Corp. v. Commissioner

*299 Respondent determined a deficiency in income tax of $ 93,079.09 for the calendar year 1945. Certain adjustments made in the notice of deficiency are not in dispute and only a portion of this deficiency is in controversy. The issue presented is whether the respondent erred in including in 1945 income of the petitioner, who is on the accrual basis, $ 181,075.02, which was received by petitioner in 1946 and reported as taxable income in that year. The income involved represents compensation paid for certain packaging and preservation work done by the petitioner in the calendar year 1945 under Government contracts. Some of the facts were stipulated and are included in the findings by this reference.

FINDINGS OF FACT.

Petitioner is*170 an Illinois corporation with its principal office in Chicago, Illinois. The returns for the period involved were filed with the collector of internal revenue for the first district of Illinois on March 15, 1946. At all times material to this proceeding petitioner has kept its books and filed its income tax returns on a calendar year basis and the accrual method of accounting.

*300 During the calendar year 1945 one portion of petitioner's business consisted of manufacturing for the United States Government certain aerial target assemblies, together with spare parts therefor, under four separate contracts. The provisions of these contracts are substantially similar and are the same insofar as provisions are concerned which affect the question here in issue. In two of the contracts, Nos. 9112 and 6443, the contract price did not include compensation for packaging and preservation services but provided that the amount to be paid for such services would be negotiated with the contractor after delivery and an amount arrived at upon a fair and equitable basis. In contracts Nos. 6313 and 1745 the method of packaging was provided in the original contract and the contract price included*171 compensation for such packaging and preservation services. However, in both these contracts there were change orders or amendments directing changes in the method of packaging, which increased the cost of such services. In both such contracts it was provided that in case a change in specifications was directed by the Government which increased or decreased the cost of manufacture, the increase or decrease of the amount to be paid under the contract would be negotiated after completion of deliveries and the additional amount due the contractor or credit due the Government under this negotiation would be arrived at upon a fair and equitable basis. All of the contracts carried provisions that if the negotiation of a fair amount satisfactory to both parties was not arrived at, appeal could be taken by the contractor to the head of the department. All contracts provided that the amount ultimately arrived at as the fair and just compensation to be paid was to be specified in an amendment to be executed to the contract. Payment for this packaging and preservation service was to be made upon each contract only after the amendment was executed.

Under the contracts here involved there *172 was disagreement between the petitioner and the contracting officer over the additional price to be paid for the packaging and preservation services. All packaging had been delivered in 1945 with respect to items here in controversy. There was disagreement between petitioner and the contracting officer on the method of ascertaining the cost of packaging. At times the Government representatives favored a specified percentage of the cost of the articles, while petitioner sought to base packaging costs on experience over a period of 60 to 90 days and determine on this basis a unit cost. In the procedure followed by the petitioner and the Government in its efforts to negotiate the price to be paid for these services the same general course was followed in each contract. The record of the steps taken on Contract 9112 is typical and will be set out for purposes of illustration.

Under Contract 9112, approved May 28, 1945, the petitioner was to manufacture and deliver certain assemblies and parts for power-driven *301 airplane targets at a total price of $ 703,854.53. These were to be packaged for domestic or export shipment according to Government instructions. The cost of packaging*173 was not provided for or included in the price of the article. A "fair and reasonable" price was provided to be negotiated between the contractor and the Government after the service was rendered and in case of an inability to agree the contractor was given the right to appeal to the Secretary of War. There were certain provisions providing the method of determination in case of such appeal which are not involved herein.

In accordance with the terms of the contract the petitioner, after completion of the work of packaging and preservation, submitted, on December 6, 1945, a quotation in the amount of $ 165,893.07, as representing its estimate of a fair and just price to be paid for this additional work. This quotation had been made upon petitioner's estimate of the cost of material, labor, and overhead, to which it had added a profit of 7 per cent. This quotation was unacceptable to the contracting officer, and between December 6, 1945, and March 27, 1946, petitioner was visited by Government representatives in an effort to negotiate a settlement at a lesser figure. As a result of these discussions petitioner verbally agreed to reduce its quotation by 30 per cent, and submitted*174 on the last-mentioned date an amended quotation providing for additional payment in the sum of $ 116,125.15.

Subsequent to the above action additional discussions were had between the Government and petitioner, as a result of which the Government offered in settlement the sum of $ 100,435.95, which figure was accepted by petitioner and another amended quotation in this amount was forwarded the Government on April 26, 1946, and on or about June 5, 1946, a change order was executed by the Government amending the contract to provide that these additional services would be paid for by an addition to the contract price in the aforesaid sum of $ 100,435.95. This amendment was formally accepted by the petitioner on July 1, 1946, and upon receipt by petitioner of a copy of the amended contract on August 1, 1946, petitioner submitted an invoice in the agreed amount which was subsequently paid by the Government.

Of the total of $ 100,435.95, the sum of $ 75,525.92 related to the packaging of assemblies and spare parts delivered in 1945. The balance related to deliveries made in 1946, and petitioner's accrual of that portion of the payment in that year is not questioned by the respondent. *175 The amount of $ 75,525.92, pertaining to assemblies and spare parts delivered in 1945 but paid for as above set out in 1946 was accrued by petitioner in the latter year.

Contract 6313 involved two change orders, one executed by the contracting officer of the Government on April 25, 1946, in the amount of $ 12,548.52 and one executed by the contracting officer on July 2, 1946, in the amount of $ 18,290.65. Under contract 1745, a change order *302 finally fixing the amount payable to petitioner for packaging was executed by the contracting officer on April 25, 1946, in the amount of $ 35,865.03, and under contract 6443, an amendment fixing the compensation payable to petitioner for packaging in the amount of $ 55,325.07, prepared by the Government on March 12, 1946, was received and accepted by petitioner on March 18, 1946. An invoice in the amount of $ 46,148 was submitted by petitioner on March 30, 1946, the difference between this and the $ 55,325.07 authorized by the amendment resulting from a smaller number of items having been packaged, the unit price being unchanged. Of this amount $ 38,844.90 represented the packaging cost of items shipped during 1945 and the balance*176 1946 deliveries.

The above amounts ($ 75,525.92, $ 12,548.52, $ 18,290.65, $ 35,865.03, and $ 38,844.90) constitute the total amount of $ 181,075.02 received in 1946 by petitioner and accrued by it in 1946, and which respondent has included in petitioner's income for 1945 in determining the deficiency here in issue.

Not until 1946, when the amounts to be paid petitioner for the services here involved were determined and fixed as a result of negotiation between the parties, was it possible for the amount of such payments to be ascertained with reasonable accuracy.

OPINION.

Respondent determined a deficiency in petitioner's income tax for 1945 after several adjustments, only one of which remains in controversy. The action with respect to this item was explained in the notice of deficiency as follows:

Under the authority of, and in compliance with the provisions of section 41 of the Internal Revenue Code, it is held that $ 181,075.02 received as payment under the terms of certain contracts, is income in 1945 as provided in section 42 of the Internal Revenue Code and regulations issued thereunder. Your income is, therefore, increased $ 181,075.02 under the provisions of section 22 (a) *177 of the Internal Revenue Code.

Petitioner assigned this action as error.

The apposite Code sections are those cited in the deficiency notice. Neither they, however, nor Regulations 111, sections 29.41-1 and 29.42-1, issued thereunder, contain language dispositive of the issue raised by the pleadings. Section 41 of the Internal Revenue Code provides that "The net income shall be computed upon the basis of the taxpayer's annual accounting period * * * in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; * * *." Section 42 provides that "The amount of all items of gross income shall be included in gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under section 41, any such amounts are to be properly *303 accounted for as of a different period. * * *" Petitioner kept its books and filed its income tax returns on the calendar year basis and the accrual method of accounting. The sole question presented therefore is whether the income in question accrued within the year 1945 as contended by respondent, or in 1946 as contended by petitioner. This issue, as in Boston Elevated Railway Co., 16 T. C. 1084*178 (affirmed on another point, which was the only issue presented on appeal, 196 F. 2d 923), turns upon the application of the principles of accrual accounting to the facts of this case. In that case we stated:

These principles have long been understood and applied in a wide variety of cases. Thus, it has been held that liability for a tax accrues and is deductible from gross income, when "all the events" have occurred "which fix the amount of the tax and determine the liability of the taxpayer to pay it." United States v. Anderson, 269 U.S. 422, 441. Moreover, an item may be accrued, "if there is legal liability, even though the amount is not definitely fixed, if all the events have occurred by which the amount may be determined with reasonable exactitude. Continental Tie & Lumber Co. v. United States, [286 U.S. 290]." Lehigh Valley Railroad Co., 12 T. C. 977, 995. But where the item, whether of income or deduction, depends upon a contingency or future events, it may not be accrued until the contingency or events have occurred and fixed with reasonable certainty*179 the fact and amount of the liability involved. United States v. Safety Car Heating Co., 297 U.S. 88, 93-94; Lucas v. American Code Co., 280 U.S. 445, 451, 452.

See also William Justin Petit, 8 T. C. 228; Luckenbach Steamship Co., 9 T. C. 662; Henry Hess Co., 16 T. C. 1363 (pending on appeal C. A. 9).

In Henry Hess Co., supra, where the amount of gain resulting from the requisitioning for title in 1942 by the War Shipping Administration of one of the vessels of a steamship company was not reasonably ascertainable in the taxable year 1942, subject company being on the accrual basis of accounting, we held that no amount of gain was includible in the income of the company in 1942. In so holding we stated:

The amount of just compensation to be received was not fixed or reasonably ascertainable in the year 1942. It is not enough to state that the Fifth Amendment to the Federal Constitution guarantees just compensation and thereby fixes taxpayer's right. To this it might, with equal assurance, *180 be rejoined that under our system of jurisprudence and the law as adjudicated by all American courts, every litigant is guaranteed ultimate justice or "equal justice under law." These principles are basic in our system of government. So to state, however, does not devitalize the considerations leading to the holding in innumerable cases that before an amount can be accrued, not only must the right to receive the amount be fixed, but the amount must be reasonably ascertainable.

Until a definite amount was arrived at under the negotiations provided for in the contracts involved herein petitioner had only a claim on a quantum meruit basis for goods and services rendered which, while of value, was too uncertain in amount to accrue. Henry Hess Co., supra;United States Cartridge Co. v. United States, 284 U.S. 511; Durr Packing, Inc. v. Shaughnessy, 81 F. Supp. 33, affd. per curiam, *304 189 F. 2d 260; Patrick McGuirl, Inc. v. Commissioner, 74 F. 2d 729, certiorari denied 295 U.S. 748; Craig v. Thompson, 177 F. 2d 457;*181 William Justin Petit, supra;Cold Metal Process Co., 17 T. C. 916, affd. C. A. 6, November 21, 1952.

The situation here presented is not to be confused with that in Dumari Textile Co., 47 B. T. A. 639, affd. 142 F. 2d 897, relied on by respondent. In that case the taxpayer, on the accrual basis, was reimbursed in 1938 for a processing tax burden borne by it on account of the floor stock tax. Payment was made to taxpayer pursuant to section 602 of the Revenue Act of 1936. The Board held, following Continental Tie & Lumber Co. v. United States, 286 U.S. 290, that the payment received by taxpayer in 1938 accrued in 1936 because the right to the payment ripened when the statute authorizing it was enacted. The Board stated in its opinion:

The statute provided that:

"There shall be paid to any person who, at the first moment of January 6, 1936, held for sale or other disposition * * * any article processed * * * from a commodity subject to processing tax, an amount computed as provided in subsection (b), * * *"

Thus, the payment under*182 this section was mandatory if petitioner held any article within the scope of the section. The right to receive the payment was not contingent on any future event. Everything had happened which could have happened from which to determine the amount of the payment. There remained only the necessity of filing the claim and proving the facts to the Commissioner of Internal Revenue for petitioner to become entitled to the payment. These requirements, obviously, had no bearing on when the payment accrued since they did not affect the amount. [Emphasis supplied.]

The Board went on to say: "This was purely a matter of computation under the express direction of the statute." Both the Dumari Textile Co. and Continental Tie & Lumber Co. cases are distinguishable from the situation before us in that here more than a mere calculation or computation was required to fix the amount to be accrued. Rather there remained a negotiation between the parties upon terms not as yet agreed upon. There was no formula, method, or particular data which both could accept as the basis of the final agreement. Also the amount finally arrived at as the fair and just compensation to be paid*183 was required to be set forth in an amendment to the contract before payment could be made.

Thus we conclude from the whole record that petitioner was not able to ascertain with reasonable accuracy the amount to accrue until 1946 when the negotiations were completed and the change orders or amendments were executed. That amount was, therefore, not fixed and definite until 1946, at which time it was properly accrued. Such accrual is not precluded by the fact that the items of cost, representing labor, material, and overhead, pertaining to these items were accrued *305 by petitioner in 1945 and reflected in the computation of taxable income for that year. As to such amounts, liability and amount were fixed in that year. Foster Wheeler Corporation, 20 T. C. 15.

Other adjustments set forth in the notice of deficiency are no longer in controversy and were not assigned as error.

Decision will be entered under Rule 50.