The respondent determined deficiencies, an addition to the tax and transferee liabilities, in respect of income taxes of the Pittsburgh Milk Company, a dissolved corporation, as follows: ^{fn1 fn1 fn2 fn1 fn2 fn3 fn3 fn3 fn3 fn3 fn3 fn3 fn3 fn3 fn3}

In Docket Nos. 40272 and 48227, relating to transferee liabilities of Estyre Vinocur Tucker, it has been stipulated that, without prejudice to the contentions of the parties in Docket No. 48228, there are no liabilities due from the petitioner for any of the taxable periods involved. Decisions to that effect will be entered.

In all pending cases, it has been stipulated that the final short taxable period of the dissolved corporation extended from April 1, 1949, to January 24, 1950, and not from April 1, 1949, to October 31, 1949. Accordingly, in Docket Nos. 40271 and 40273-40275, the decisions will indicate that there is no deficiency or transferee liability, as the case may be, due from any of the petitioners therein for the period from April 1, 1949, to October 31, 1949.

Also, certain issues raised by the pleadings in the several cases have been eliminated, or deferred for settlement under Rule 50 of this Court:

Respondent has conceded, on brief, that the addition to tax under section 291 (a), determined against the dissolved corporation and its transferees, in Docket Nos. 48223-48226 and 48228, should not be imposed.

It has been stipulated that the petitioners in Docket Nos. 40273-40275, 48223-48225, and 48228 are transferees of the Pittsburgh Milk Company, dissolved, within the meaning of section 311 of the Internal Revenue Code (1939); and that, as such, said petitioners are liable for any deficiency or deficiencies in income tax, which may be due in respect of said dissolved corporation for any or all of the taxable periods here involved, together with interest thereon according to law.

The amount of charitable contributions made by the corporation in each of its fiscal years ended in 1947 and 1948 has been stipulated; and such amounts will be given consideration in the computations under Rule 50.

The amounts, if any, allowable as carrybacks or carryovers in respect of net operating losses of the corporation also will be settled in the computations under Rule 50.

Issues raised in the pleadings respecting the Commissioner's adjustment of deductions for Pennsylvania corporate net income tax were not prosecuted; and they are deemed to have been abandoned.

The sole remaining issue for decision here is, whether allowances (sometimes called discounts or rebates) which the corporation made to certain purchasers of its milk in willful violation of the Milk Control Law of Pennsylvania, should be applied either as reductions from the corporation's gross sales, or as deductions from its gross income.

FINDINGS OF FACT.

Certain facts have been stipulated, and these are incorporated herein by reference.

The Pittsburgh Milk Company was incorporated under the laws of the Commonwealth of Pennsylvania on January 31, 1928; and it was dissolved on January 24, 1950. During all periods here involved it had its principal office in Pittsburgh; and it sold, both at wholesale and retail in the Commonwealth of Pennsylvania, fluid milk and other products, including cream, buttermilk, cottage cheese, ice cream, orangeade, lemonade, butter, and eggs. It kept its books of account and filed its income tax returns in accordance with the accrual method of accounting and, except for its final short period, on the basis of fiscal years ended March 31. Its income tax returns for each of its fiscal years ended in 1947, 1948, and 1949 were filed with the collector of internal revenue for the twenty-third district of Pennsylvania. Due to an error in determining the length of its final short period, no income tax return was filed for the period of April 1, 1949, through January 24, 1950.

At the time of dissolution, the corporation transferred all its assets in complete and final liquidation to the following shareholders who then owned, in equal shares, all of the corporation's issued and outstanding capital stock:

David A. Vinocur Morris Vinocur Louis M. Vinocur Morris Vinocur and David A. Vinocur, Trustees under a Trust Indenture dated January 10, 1946, between Estyre V. Tucker, Donor, and Morris Vinocur and David A. Vinocur, Trustees, for the Benefit of Judy Tucker and Shirley Tucker.

Each and all of said shareholders are transferees of the dissolved corporation, within the meaning of section 311 of the Internal Revenue Code (1939); and, as such, they are liable for any deficiency or deficiencies in income tax which may be due in respect of said corporation for any or all of the taxable periods here involved, together with interest thereon according to law.

The corporation was, during each of the periods here involved, licensed to operate as a milk dealer under the Milk Control Law of Pennsylvania.^fn2 This law, among other things:

1. Declared that the sale of milk in the Commonwealth was a business affecting the public health and affected with a public interest; and declared that such law was enacted in the exercise of the police power of the Commonwealth, for the purpose of regulating and controlling the milk industry in the Commonwealth, for the protection of the public health and welfare, and for the prevention of fraud;

2. Created an independent commission, known as the Milk Control Commission, and vested such Commission with power to supervise, investigate, and regulate the entire milk industry of the Commonwealth, including the sale of milk and milk products in the Commonwealth;

3. Required milk dealers, with certain exceptions not here relevant, to obtain licenses from the Commission before selling or distributing milk within the Commonwealth;

4. Authorized the Commission to establish various milk marketing areas within the Commonwealth; to fix minimum wholesale and retail prices for milk within each of such areas; to issue rules, regulations, and orders; and to conduct such hearings as it might deem necessary to carry out the provisions of the law; and

5. Provided procedures whereby violations could be punished, either in summary proceedings before the Commission or in proceedings before the courts of Pennsylvania, by the imposition of specified fines and periods of imprisonment; and also procedures by which violations could be enjoined by the courts.

Said law specifically provided:

Sec. 700j-807. Violations.

* * * * * * *

No method or device shall be lawful whereby milk is bought * * * sold or handled or delivered or made available on consignment or otherwise, at a price less than the minimum price applicable to the particular transaction, whether by any discount, premium, rebate, free service, trading stamps, advertising allowance, or extension of credit, or by a combined price for such milk, together with another commodity or a service which is less, or is represented to be less, than the aggregate of the price of the milk and the price or value of such commodity or service when * * * sold or delivered or made available * * * separately or otherwise.

* * * * * * *

The act of a director, officer, agent or other person acting for or employed by a milk dealer shall be deemed the act of such milk dealer.

The Milk Control Law was designed primarily to help farmers and other milk producers; and the minimum resale price provisions thereof were not popular in the urban centers. There was extensive violation by milk dealers. The Milk Control Commission did not have sufficient personnel or funds to provide adequate enforcement; but it did conduct numerous investigations of alleged violations, and it instituted a substantial number of proceedings in the courts to restrain or punish violators.

The Pittsburgh Milk Company, during each of its fiscal years ended in 1947, 1948, and 1949, made allowances, discounts, or rebates (hereinafter sometimes called, solely for purposes of description, allowances) to certain purchasers of its milk, in willful violation of the Milk Control Law and of minimum price orders of the Milk Control Commission. Such allowances were made with full knowledge of its officers and directors. These officers knew that competitors of the corporation were making similar allowances; and they believed it necessary for their corporation to do the same, in order to maintain its competitive position in the industry.

These allowances were made by the corporation pursuant to informal agreements which it had with certain of its customers; and such agreements were entered into for the purpose of avoiding the provisions of the Milk Control Law. As to each such customer, the amount of the allowance was computed by applying a specific percentage (which was not the same for all customers) to the list prices fixed by the Milk Control Commission, so as to result in a net cost to the customer which was below such list prices. Not all of the customers received such allowances; and some of those who did receive them were charitable institutions. In some instances, the rate of allowance for a particular customer varied from month to month. Also, the rate of allowance for a customer did not apply uniformly to all purchases, because in some instances and in respect to some products there was no agreement that any allowance would be made from the list price.

The manner in which the allowances were handled and paid was as follows:

The corporation delivered its milk and milk products to its customers, and recorded the deliveries on daily delivery tickets which were posted to its detailed accounts receivable or cash sales records. These accounts receivable records showed, in the case of each customer: (a) The amount of the daily sales to such customer, which reflected the list prices fixed by the Milk Control Commission; and (b) the total amount of billings to such customer, which likewise reflected the list prices fixed by the Milk Control Commission. These records in no way indicated that any allowance, rebate, or discount was to be made from such list prices.

Each customer was billed for and paid the total amount of the billings shown in his account. And when payment was received from the customer, such payment was debited to "Cash" and credited to the account receivable maintained for such customer.^fn3

At about the end of each month, the accounting personnel of the corporation reviewed the monthly accounts receivable totals and sales totals; and from such review they prepared a single monthly "Entry Voucher," which set forth the computation of the aggregate amount of allowances to be made for the month. This voucher indicated, in columns, the following:

Route Number (indicating the location and the number of the route applicable to each customer);

Rate (indicating, in the case of each customer, the particular percentage rate of the allowance to be made pursuant to the informal agreement with such customer);

Sales for the Month (indicating, in the case of each customer, the total sales of milk and milk products made to him during the month, based on the amount of money received or the amount of units sold);

Amount of Discount (indicating, in the case of each customer, the allowance for the month, computed by multiplying the total sales made to him during the month by the applicable rate of allowance); and

Check Number (indicating, in the case of each customer, the number of the check issued for the amount of the allowance computed).

Upon completion of the above-mentioned monthly computation, the following entry of a summary nature was made on the corporation's books: Debit advertising expense, credit accrued advertising. The result was that the corporation's profit and loss account for such period contained, under the single descriptive word "Advertising," the total amount of the allowances made for the applicable period. Also, the corporation's balance sheet for each period showed, as an accrued liability under the designation "Accrued Advertising," the total amount of the accrued allowances. Upon payment of the allowances, the amounts thereof were debited to accrued advertising, and credited to cash.

The method by which most of the allowances for any previous monthly period were paid was that the corporation first issued its check for the aggregate amount due the customers, either to one Dubin (a well known advertising man who was a friend of officers and directors of the corporation) or to M. S. Molnar (the corporation's bookkeeper) or to David A. Vinocur (an officer of the corporation); and such person then, in turn, issued checks for the same total amount. These latter checks were prepared by officers or employees of the corporation, and drawn on special accounts that it had opened in the names of these intermediaries for such purpose. In some cases, these latter checks were forwarded directly to the customers; and in the case of certain customers who were charitable institutions, the checks were delivered to officers of the corporation who made the payments to the customers. In a few instances, cash in the amount of the allowances was turned over to the corporation's truck drivers, for distribution to the customers. Dubin and the other intermediaries, through whom the payments were made, knew that the purpose of such arrangement was to avoid the provisions of the Pennsylvania Milk Control Law.

The corporation, during its fiscal years ended in 1947 and 1948, made at least 2,000 such allowances, and the aggregate amounts thereof for its fiscal years ended in 1947, 1948, and 1949 were, respectively, $41,952.28, $57,621.86, and $10,948.50.

The Pennsylvania Milk Control Commission was not aware of the procedure by which the corporation paid the allowances through Dubin and the other intermediaries; and its investigators never requested, and were never refused, the right to examine the accounts of these intermediaries. Such accounts were readily made available to the internal revenue agents who examined the corporation's income tax returns.

During the period from April 1, 1948, through January 24, 1950, the corporation was not cited by the Milk Control Commission for any violation of the Milk Control Law. In accordance with the rules and regulations of said Commission, it filed financial statements annually with the Commission.

The corporation, on its income tax return for each of its fiscal years ended in 1947, 1948, and 1949 claimed, as a deduction for "Advertising," the above-mentioned amount of the allowances made for such year. The respondent, in his several notices of deficiency, disallowed these deductions.

The prices for which the corporation sold milk to certain of its customers were the net prices previously agreed upon, which were determined by reducing the prescribed list prices of the Milk Control Commission by the agreed specific rates of allowance.

OPINION.

PIERCE, Judge:

The question here is what effect, if any, should be given for income tax purposes to the allowances (sometimes called discounts or rebates) which the petitioner corporation made to certain purchasers of its milk in willful violation of the Milk Control Law of Pennsylvania.

The petitioners' position is that such allowances should be given effect in either of two ways (each of which would yield substantially the same tax result): (1) That such allowances should be applied to reduce the corporation's gross sales, on the theory that the milk actually was sold for agreed net prices, represented by the difference between the list prices fixed by the Milk Control Commission and the amounts of allowances computed at agreed specific rates; or (2) in the alternative, that such allowances should be recognized as deductions from gross income, for ordinary and necessary business expenses in the nature of advertising or sales promotion expense.

The respondent's position, on the other hand, is that both of such contentions should be rejected. He contends that the milk was sold for the list prices fixed by the Milk Control Commission, because these list prices were used in entering the sales on the corporation's books; that the allowances cannot be given effect unless they qualify as deductions from gross income; and that they should not be recognized as deductions in the circumstances here present, because this would frustrate the sharply defined policy of the Commonwealth of Pennsylvania.

In considering petitioners' first contention that the allowances should be applied to reduce the corporation's gross sales, it is necessary to keep in mind certain basic principles. We are here dealing with the taxation of income. Under both the Sixteenth Amendment and the Internal Revenue Code, the tax is imposed only on "income," and not upon every conceivable type of receipt. Where gains, profits, and income derived from the sale of property are involved, the tax is computed with respect to "the amount realized therefrom" (sec. 111 (a), 1939 Code); and such realized amount must be based on the actual price or consideration for which the property was sold, and not on some greater price for which it possibly should have been, but was not, sold. Gains are taxed, irrespective of whether the transaction was legal or illegal ( United States v. Sullivan, 274 U.S. 259); but no more than the actual gross income can be subjected to income tax, in any event. ( Lela Sullenger, 11 T.C. 1076.) And finally, after the true nature of a transaction has been revealed, if it is found that the book entries do not accurately reflect the income realized, then the tax must be computed with respect to the income, rather than with respect to such entries. The actual facts, not bookkeeping entries, control the determination of taxable income. Doyle v. Mitchell Bros. Co., 247 U.S. 179, 187; Northwestern States Portland Cement Co. v. Huston, (C. A. 8) 126 F.2d 196.

We are convinced in the instant case, and have found as a fact, that the milk here involved was not sold at the list prices fixed by the Milk Control Commission, but rather for net prices which resulted from reducing these list prices by certain allowances computed at specific rates fixed by prior agreements with the customers. The parties have stipulated: That the allowances were given "pursuant to informal agreements with such customers made for the purpose of avoiding the provisions of the Pennsylvania Milk Control Law"; that the specific percentage rates of these allowances were determined pursuant to the informal agreements; and that such specific percentage rates were applied "so as to result in net cost to the customer below that represented by Milk Control Commission list prices." Thus it will be seen that the Commission list prices were used merely as the starting point in agreed formulas for arriving at the agreed net prices for the milk; and that the so-called allowances represented merely the difference between the said list prices and the agreed selling prices.

The situation presented is not unlike that where goods are sold at a catalog list price, less a trade discount of specified percentage. This Court has recognized that trade discounts should be applied to reduce gross sales. American Lace Mfg. Co., 8 B. T. A. 419; American Cigar Co., 21 B. T. A. 464; Albert C. Becken, Jr., 5 T.C. 498, 505. Also, Treasury Form 1120 (United States corporation income tax return) makes specific provisions, in line 1 thereof, for the reduction of "gross sales" by "returns and allowances"; and it further indicates that such adjustment should be made before subtracting "cost of goods sold" to arrive at "gross profit."

Such treatment of the sales transactions is not affected by the fact that the sales were made at less than the minimum prices fixed by the Milk Control Commission. If the corporation had, entirely apart from the allowances and book entries which it employed, actually sold a given quantity of milk for $9 cash, in willful disregard of a minimum price of $10 fixed by the Milk Control Commission, there can be no doubt that any gain or profit resulting from such sale would have to be computed, for income tax purposes, with respect to the actual $9 selling price, and not with respect to some greater price for which the milk might have been, but was not, sold. It is possible that the sale for the lesser price might have enabled the Milk Control Commission to suspend or revoke the corporation's license as a milk dealer, or to seek injunction against further violations, or to invoke criminal penalties for the violations. But, so far as the Federal income tax is concerned, such tax could be imposed only in respect of the $9 price for which the milk was sold.

It is our opinion that such income tax result is the same where the parties, after having agreed between themselves that the milk would be sold and purchased for the price of $9, deliberately masked and concealed the true character of the transaction from the Milk Control Commission, by having the purchaser first deliver its check for $10 to the seller, and then having the seller issue a counter-check for $1 to the purchaser, in order to arrive at the agreed selling price. In this situation, the seller did not receive the extra $1 beneficially or under any claim of right, but merely as a deposit which was to be returned in all events. We voice no approval of the business ethics of such concealment; but, as the Supreme Court said in Commissioner v. Wilcox, 327 U.S. 404, "Moral turpitude is not a touchstone of taxability."

It does not follow, of course, that all allowances, discounts, and rebates made by a seller of property constitute adjustments to the selling prices. Terminology, alone, is not controlling; and each type of transaction must be analyzed with respect to its own facts and surrounding circumstances. Such examination may reveal that a particular allowance has been given for a separate consideration — as in the case of rebates made in consideration of additional purchases of specified quantity over a specified subsequent period; or as in the case of allowances made in consideration of prepayment of an account receivable, so as to be in effect a payment of interest. The test to be applied, as in the interpretation of most business transactions, is: What did the parties really intend, and for what purpose or consideration was the allowance actually made? Where, as here, the intention and purpose of the allowance was to provide a formula for adjusting a specified gross price to an agreed net price, and where the making of such adjustment was not contingent upon any subsequent performance or consideration from the purchaser, then, regardless of the time or manner of the adjustment, the net selling price agreed upon must be given recognition for income tax purposes.

We hold that the allowances here involved should be applied to reduce the corporation's gross sales, so as to reflect the actual agreed prices for which the milk was sold. By reason of such holding, it is unnecessary to consider the petitioners' alternative contention that the allowances would qualify as deductions from gross income.

Decision of no liability will be entered in Docket Nos. 40272 and 48227, pursuant to stipulations filed by the parties.

Decisions will be entered under Rule 50 in the remaining docket numbers.