Opinion
Docket No. 15015.
1949-05-26
NATIONAL BUILDERS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Orin M. Culman, Esq., for the petitioner. Jackson L. Boughner, Esq., for the respondent.
Petitioner was a member of a joint venture which in 1942 and 1943, under a a contract with the Government, constructed buildings at an Army base. Although the contract was substantially completed by the joint venture and its work accepted prior to the close of its first fiscal year on March 31, 1943, final payment of $362,778.33 was frozen by the Government pending renegotiation of the profits realized on the contract. The $362,778.33 was paid to the joint venture on August 16, 1943, and the joint venture, which was on the cash receipts and disbursements basis, reported that amount as income and deducted various sums as expenses in its return for the fiscal year ended March 31, 1944. The Under Secretary of War on December 21, 1944, made a unilateral determination that the joint venture had realized excessive profits of $575,000, which amount was repaid by the members of the joint venture in cash and by way of a tax credit computed under section 3806(b)(1) of the Internal Revenue Code. Immediately thereafter the joint venture filed a petition for a redetermination of the finding of excessive profits made by the Under Secretary of War, which proceeding is at present pending before this Court. Held:
(1) That the respondent, in determining the income of the joint venture for the fiscal year ended March 31, 1943, and the petitioner's distributable share thereof, erred in reallocating contract costs to years other than the year in which they were actually paid.
(2) In determining the amount of any deficiency or overpayment, petitioner's tax liability for 1943 should be computed without reference to adjustments under section 3806 incident to the renegotiation of its Government contracts. Orin M. Culman, Esq., for the petitioner. Jackson L. Boughner, Esq., for the respondent.
This case involves a deficiency in income tax of $2,903.43 and in excess profits tax of $45,449.49 for the year 1943 as determined by the respondent in his notice of deficiency. By way of amended answer, respondent claims these deficiencies for 1943 should be increased in the amounts of $925.56 in income tax and $156,913.69 in excess profits tax.
The principal question for determination is whether the respondent, in determining petitioner's income tax liability for 1943, was justified in allocating business expenses of a joint venture of which the petitioner was a member to a year other than the year of actual payment upon the basis that the reallocation more clearly reflects the joint venture's true income than the cash receipts and disbursements method it employed.
The second issue herein, which is raised by amended answer, concerns the treatment, in respect to the petitioner's tax liability for 1943, of the excessive profits repaid by the petitioner to the Government under renegotiation proceedings in cash and by way of a tax credit computed under section 3806 of the Internal Revenue Code. Petitioner has abandoned an issue raised in the petition in respect to an adjustment by respondent of its income for the taxable year 1942 and does not contest various other adjustments made by the respondent to its income for the taxable year 1943.
The facts have been stipulated and, in so far as may be necessary to an understanding of the issues, they are set forth below.
FINDINGS OF FACT.
National Builders, Inc., hereinafter referred to as the petitioner, is a corporation, organized and existing under the laws of the State of Minnesota, with its principal office in Minneapolis, Minnesota. Petitioner kept its books on the accrual basis and filed its Federal income tax returns for the years involved on calendar year basis with the collector of internal revenue for the district of Minnesota.
The petitioner and A. Hedenberg & Co., of Duluth, Minnesota, another Minnesota corporation, and the B. H. Stahr Co. of Minneapolis, Minnesota partnership consisting of B. H. Stahr and Roger B. Stahr, entered into a joint venture agreement on April 17, 1942. All the members of this joint venture was engaged in the general contracting business.
The respective interests of the members of the joint venture were as follows:
+---------------------------+ ¦National Builders, Inc ¦35%¦ +-----------------------+---¦ ¦B. H. Stahr & Co ¦35%¦ +-----------------------+---¦ ¦A. Hedenberg & Co ¦30%¦ +---------------------------+
The joint venture kept its books and filed its Federal tax returns on the cash receipts and disbursements basis for fiscal years ending on March 31 of each year. Partnership returns of its income were filed for the fiscal years ended March 31, 1943 and 1944, with the collector of internal revenue for the district of Minnesota.
On April 16, 1942, the joint ventures entered into an agreement with the United States Government to construct, prior to October 3, 1942, certain facilities at Camp McCoy, near Sparta, Wisconsin, for a consideration of $4,552,210. The original contract was modified by various change orders, which resulted in a final contract price of $4,554,733.17. Construction work by the joint venture was commenced on April 16, 1942, and was completed, approved, and accepted by the Government prior to March 31, 1943. No work was done on the project site after March 31, 1943, except for repairs costing $2,164.55, which were completed in December 1943.
As schedule of the receipts and disbursements of the joint venture for the fiscal years ended March 31, 1943 and 1944, is as follows:
+--------------------------------------------+ ¦ ¦¦Fiscal ¦Fiscal ¦ +-----------------++-------------+-----------¦ ¦ ¦¦year ¦year ¦ +-----------------++-------------+-----------¦ ¦ ¦¦ended ¦ended ¦ +-----------------++-------------+-----------¦ ¦ ¦¦3/31/43 ¦3/31/44 ¦ +------------------+-------------+-----------¦ ¦RECEIPTS ¦ ¦ ¦ +------------------+-------------+-----------¦ ¦Contract receipts¦¦$4,191,954.84¦$362,778.33¦ +-----------------++-------------+-----------¦ ¦Labor sold ¦¦4,520.96 ¦ ¦ +-----------------++-------------+-----------¦ ¦Miscellaneous ¦¦7,997.70 ¦ ¦ +-----------------++-------------+-----------¦ ¦Insurance rebates¦¦ ¦26,003.26 ¦ +-----------------++-------------+-----------¦ ¦Total receipts ¦¦4,204,473.50 ¦388,781.59 ¦ +-----------------++-------------+-----------¦ ¦ ¦¦ ¦ ¦ +--------------------------------------------+
DISBURSEMENTS Expenses paid $3,424,874.00 72,688.04 Less cash discounts taken 8,117.34 3,416,756.66 Excess of receipts over disbursements 787,716.84 316,093.55
In 1942 the Under Secretary of War commenced proceedings to renegotiate the construction contract in question and the final payment was frozen in that year. On March 24, 1943, the Price Adjustment Section of the War Department advised petitioner orally at a conference held in Chicago, Illinois, that the amount of $700,000 was considered to be excessive profits under the Renegotiation Act.
On August 11, 1943, the joint venture received from the Government approved final estimate for payment, and on August 16, 1943, it received final payment in the amount of $362,778.33.
On December 21, 1944, the Under Secretary of War ‘made a unilateral determination that $575,000 of the prices and profits realized by National Builders Inc., B. H. Stahr Company and A. Hedenberg and Company, Inc., joint contractors and co-adventurers, on the above mentioned contract subject to renegotiation pursuant to the provisions of Section 403, are excessive.‘
On March 12, 1945, the internal revenue agent in charge at St. Paul, Minnesota, computed, under section 3806(b) of the Internal Revenue Code, the amount of offsetting tax credit of petitioner based upon excessive profits of $575,000. Of the $575,000 repaid to the Government by the joint venture, petitioner was liable for $201,250, or 35 per cent, of the total amount. respondent determined that $185,220.70 of the $201,250 should be eliminated from petitioner's taxable income for the year 1943. The result of this adjustment was to give tax credits of $2,158.36 for normal tax and surtax and $113,590.98 for excess profits tax, or an aggregate of $115,749.34. By the application of this credit and the payment in cash of $85,500.55, petitioner fully repaid to the Government its share of what had been determined as excessive profits.
Under date of April 1, 1947, respondent determined a tax deficiency against petitioner for the year 1943. This deficiency arose by reason of respondent recomputing the income of the joint venture for 1943, wherein he reallocated contract costs between the fiscal years ended March 31, 1943 and 1944, upon the basis of gross contract receipts in each year. The joint venture had received 92.035 per cent of the total contract receipts in the fiscal year ended March 31, 1943, and the remaining 7.965 per cent in the fiscal year ended March 31, 1944. Contract costs were then allocated between the two fiscal years upon the basis of 92.035 per cent and 7.965 per cent, instead of the manner in which they actually had been expended, that is, approximately 98 per cent in the fiscal year ended March 31, 1943, and 2 per cent in the fiscal year ended March 31, 1944.
On the basis of the foregoing reallocation of costs, respondent determined that the net profits from the joint venture before renegotiation were $1,015,898.06 for the fiscal year ended March 31, 1943, and $87,912.33 for the fiscal year ended March 31, 1944. The profits as determined represent an increase of the joint venture's net profits for the fiscal year ended March 31, 1943, in the amount of $228,181.22 and a corresponding decrease in its profits for the fiscal year ended March 31, 1944.
Respondent then determined that petitioner's distributable share of the profits of the joint venture for 1943 was $355,564.32, or 35 per cent of the total net profit of $1,015,898.06. Of the $575,000 which the joint venture was obligated to repay the Government as excessive profits, petitioner was liable for $201,250, or 35 per cent of the total amount. Respondent determined that $185,219, or 92.035 per cent of the $201,250 petitioner was obligated to pay, was attributable to the taxable year 9143 and 7.965 per cent to 1944.
The respondent's reallocation of contract costs on the basis of contract receipts resulted in a determination of the petitioner's net income in a higher amount for 1943 than would have been reached had 98 per cent of contract costs been included in 1943, as was the case under the system of accounting used by the joint venture. Respondent's reallocation of contract costs for the years 1943 and 1944, on the basis of contract receipts in those years, is as follows:
COMPUTATION OF NET INCOME FROM JOINT VENTURE
+-----------------------+ ¦Gross Contract Receipts¦ +-----------------------¦ ¦ ¦ ¦ ¦ +-----------------------+
Actual Yr. Ended Receipts Ratio 3/31/43 $4,191,954.84 92.035% 3/31/44 362,778.33 7.965% $4,554,733.17 100%
+-----------------------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦ ¦Allocated ¦ +-------+----------------------+----------+-------------+-------+-------------¦ ¦ ¦ ¦ ¦ ¦ ¦in Ratio ¦ +------------------------------+----------+-------------+-------+-------------¦ ¦Contract Costs ¦ ¦ ¦ ¦of Gross ¦ +------------------------------+----------+-------------+-------+-------------¦ ¦ ¦ ¦ ¦ ¦ ¦Contract ¦ +-------+----------------------+----------+-------------+-------+-------------¦ ¦ ¦ ¦ ¦ ¦ ¦Receipts ¦ +-------+----------------------+----------+-------------+-------+-------------¦ ¦Yr. ¦ ¦ ¦As ¦ ¦ ¦ +-------+----------------------+----------+-------------+-------+-------------¦ ¦Ended ¦ ¦ ¦Expended ¦Ratio ¦Amount ¦ +-------+----------------------+----------+-------------+-------+-------------¦ ¦3/31/43¦Actual expenditures ¦ ¦$3,404,238.00¦92.035%¦$3,176,056.78¦ +-------+----------------------+----------+-------------+-------+-------------¦ ¦3/31/44¦Actual exp ¦$72,688.04¦ ¦ ¦ ¦ +-------+----------------------+----------+-------------+-------+-------------¦ ¦ ¦Less: Insurance ¦$26,003.26¦46,684.78 ¦7.965% ¦274,866.00 ¦ ¦ ¦rebates ¦ ¦ ¦ ¦ ¦ +------------------------------+----------+-------------+-------+-------------¦ ¦Totals ¦ ¦$3,450,922.78¦100% ¦$3,450,922.78¦ +------------------------------+----------+-------------+-------+-------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
Computation of Net Profit from Joint 3/31/43 3/31/44 Total Venture Gross contract receipts—actual $4,191,954.84 $362,778.33 $4,554,733.17 Contract costs—allocated 3,176,056.78 274,866.00 3,450,922.78 Net profit before renegotiation $1,015,898.06 $87,912.33 $1,103,810.39
Division of Net Profit Before Renegotiation National Builders, Inc 35% $355,564.32 $30,769.32 $386,333.64 B.H. Stahr Co 35% 355,564.32 30,769.31 386,333.63 A. Hedenberg & Co., Inc 30% 304,769.42 26,373.70 331,143.12 100% $1,015,898.06 $87,912.33 $1,103,810.39
The respondent's basis for this reallocation was set out in the notice of deficiency as follows:
Your distributable shares of the net income from the joint venture of National Builders, Inc., B. H. Stahr Company, and A. Hedenberg and Company, Inc., for the joint venture's fiscal years ending March 31, 1943 and March 31, 1944 have been computed in Exhibits A and B attached hereto. It is held that such computations clearly reflect the net income of the joint venture, and your distributable shares thereof, under the provisions of sections 41, 42 and 43 of the Internal Revenue Code.
On the basis of this readjustment, respondent allocated the repaid excessive profits between the taxable years 1943 and 1944 as follows:
ALLOCATION OF EXCESSIVE PROFIT ON RENEGOTIATION
+-----------------------------------------------------------------------------+ ¦ ¦ ¦ ¦Excessive ¦ ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦ ¦Net Profit ¦ ¦Profits on ¦ ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦ ¦Before ¦ ¦Renegotiation¦Tax ¦Cash ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦Year ended 3/31/ ¦Renegotiation¦Ratio ¦Allocated ¦Credits ¦Payments ¦ ¦43 ¦ ¦ ¦ ¦ ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦National ¦$355,564.32 ¦32.212%¦$185,219.00 ¦$115,749.34¦$85,500.66 ¦ ¦Builders, Inc. ¦ ¦ ¦ ¦ ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦Bernhard H. Stahr¦177,782.16 ¦16.106%¦92,609.50 ¦49,100.46 ¦26,842.20 ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦Roger B. Stahr ¦177,782.16 ¦16.106%¦92,609.50 ¦50,353.91 ¦26,133.66 ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦A. Hedenberg & ¦304,769.42 ¦27.611%¦158,763.25 ¦78,837.94 ¦93,662.06 ¦ ¦Co., Inc. ¦ ¦ ¦ ¦ ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦Sub-total ¦$1,015,898.06¦92.035%¦$529,201.25 ¦ ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦Year Ended 3/31/ ¦ ¦ ¦ ¦ ¦ ¦ ¦44 ¦ ¦ ¦ ¦ ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦National ¦$30,769.32 ¦2.788% ¦16,031.00 ¦ ¦ ¦ ¦Builders, Inc. ¦ ¦ ¦ ¦ ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦Bernhard H. Stahr¦15,384.66 ¦1.394% ¦8,015.50 ¦24,682.34 ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦Roger B. Stahr ¦15,384.65 ¦1.394% ¦8,015.50 ¦24,137.43 ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦A. Hedenberg & ¦26,373.70 ¦2.389% ¦13,736.75 ¦ ¦ ¦ ¦Co., Inc ¦ ¦ ¦ ¦ ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦Sub-total ¦$87,912.33 ¦7.965% ¦$45,798.75 ¦ ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦Grand Totals ¦$1,103,810.39¦100% ¦$575,000.00 ¦$342,861.42¦$232,138.58¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦Tax credits ¦ ¦ ¦ ¦ ¦342,861.42 ¦ ¦applied ¦ ¦ ¦ ¦ ¦ ¦ +-----------------+-------------+-------+-------------+-----------+-----------¦ ¦Total repayment ¦ ¦ ¦ ¦ ¦$575,000.00¦ +-----------------------------------------------------------------------------+
On March 15, 1945, the joint venture filed a petition with the Tax Court in which it alleged error on the part of the Under Secretary of War in determining that it had excessive profits in the amount of $575,000. That proceeding is still pending before this Court.
OPINION.
ARUNDELL, Judge:
Respondent has reallocated contracts costs of the joint venture of which petitioner was a member for the fiscal years ended March 31, 1943 and 1944, in direct proportion to its contract receipts in those years. In so doing, respondent relies upon the provisions of sections 41, 42, and 43 of the Internal Revenue Code and claims that the system used by him more clearly reflects the true income of the joint venture and the petitioner's distributable share thereof.
The joint venture kept its books and filed its Federal income tax returns on the cash receipts and disbursements basis for fiscal years ended March 31 of each year. In contracting with the Government in April 1942, the joint venture anticipated completing the contract prior to the end of its first fiscal year on March 31, 1943, and it appears that the fiscal year was so chosen to avoid overlapping construction income and costs into a second taxable year.
Except for various details, all of the work under the contract was completed and had been approved and accepted by the Government prior to March 31, 1943. On March 24, 1943, the joint venture was orally advised by the Price Adjustment Section of the War Department that $700,000 of its profits were considered to be excessive and that the final payment under the contract in the amount of $362,778.33 had been frozen. It was not until August 11, 1943, that the joint venture received the withheld payment.
Respondent included in the gross income of the joint venture in each fiscal year the amounts actually received under the contract, or $4,191,954.84 in the fiscal year ended March 31, 1943, and $362,778.33 in the fiscal year ended March 31, 1944. As the joint venture kept its books on the cash receipts and disbursements basis and had no present right to receive the $362,778.33 on or before March 31, 1943 we believe that the respondent was correct in his treatment of contract receipts.
However, in the determination of the net profits of the joint venture for both years, respondent reallocated contract costs between the two fiscal years involved. Although approximately 98 per cent of the costs was actually paid in the fiscal year ended March 31, 1943, respondent readjusted costs to conform with the percentage of contract receipts in each year, including 92.035 per cent of costs in the fiscal year ended March 31, 1943, and 7.965 per cent in the fiscal year ended March 31, 1944. In this respect, we believe the respondent was in error.
Generally, four recognized accounting systems were available to the joint venture. It could have kept its books on the accrual, percentage of completion, completed contract, or cash method. It chose the latter method. Respondent concedes that in his reallocation he substituted a ‘hybrid‘ system in an effort to compromise on a uniform basis with all three members of the joint venture.
The Supreme Court, in Security Flour Mills Co. v. Commissioner, 321 U.S. 281, clearly disposed of the Commissioner's right to arbitrarily substitute such a system for that ordinarily employed by the taxpayer with the following statement:
This legal principle has often been stated and applied. The uniform result has been denial both to government and to taxpayer of the privilege of allocating income or outgo to a year other than the year of actual receipt or payment, or applying the accrual basis, the year in which the right to receive, or the obligation to pay, has become final and definite in amount.
In reference to the provisions of section 43, the Court stated:
We are of opinion that the purpose of the language which Congress used was not to substitute, whenever in the discretion of an administrative officer or tribunal such a course would seem proper, a divided and inconsistent method of accounting not properly to be denominated either a cash or an accrual system.
Regulations 111, section 29.43-2, also indicates that a departure from the cash or accrual systems is justified only where there would otherwise be a material distortion of a taxpayer's true income.
* * * The expenses, liabilities, or deficit of one year cannot be used to reduce the income of a subsequent year. A taxpayer has the right to deduct all authorized allowances, and it follows that if he does not within any year deduct certain of his expenses, losses, interest, taxes, or other charges, he cannot deduct them from the income of the next or any succeeding year. It is recognized, however, that particularly in a going business of any magnitude there are certain overlapping items both of income and deduction, and so long as these overlapping items do not materially distort the income they may be included in the year in which the taxpayer, pursuant to a consistent policy, takes them into his accounts. (Cf. Burnet v. Sanford & Brooks Co., 282 U.S. 359.)
We can find no reason herein requiring the costs of the joint venture to be apportioned under such a system as employed by the respondent. Therefore, it is our opinion that the income of the joint venture for the taxable years 1943 and 1944 may be properly determined under the cash receipts and disbursements system of accounting it used in those years.
What we have said so far we think serves to dispose of the only strict tax question raised in this proceeding. However, in determining the deficiency in this case, the respondent eliminated from the income of the petitioner and the joint venture the excessive profits repaid to the Government and treated the credit allowed petitioner under section 3806 incident to the renegotiation of its war contracts as in the nature of a rebate under section 271(b)(2) of the Internal Revenue Code, with a result that we do not think is contemplated by the statute.
The correct tax liability of a taxpayer is, in the first instance, to be determined with complete disregard of the fact that the taxpayer may have repaid amounts representing excessive profits to the Government incident to renegotiation and in making the payments received the benefit of the credit provided for by section 3806(b)(1). Petitioner's tax liability for 1943 should be computed on the basis of the gross income, deductions, and net income as shown on the return, and such other adjustments as may be required, including any resulting from the instant redetermination, so that the tax as finally computed meets the requirements of the statute. It follows that under this method the full amount of taxes paid by the petitioner should be applied against the total tax liability in determining the amount of any deficiency or overpayment, and the respondent should not, in this computation, treat the credits previously computed under section 3806(b)(1) as rebates within the definition contained in section 271(b)(2). It is not until the tax liability as such has been correctly determined that we have a basis for the computation of the credit under section 3806, and if a credit has been allowed for renegotiation purposes prior to the final determination of the tax liability as such, then the credit must be regarded as tentative and must necessarily fluctuate up or down, dependent upon what is finally determined to be the petitioner's correct tax liability.
The sole tax question presented for our consideration has been decided in favor of the taxpayer, and it might seem at first glance to leave the parties where they were. But it appears from the deficiency notice that there were other adjustments that were not contested which would serve to affect petitioner's tax liability and so a recomputation becomes necessary.
We think what we have said serves to dispose of this case and other questions raised in the pleadings as to the proper method of applying the credit need not be discussed. The application of the credit under section 3806 is an administrative one, and as the determination of petitioner's tax liability is in nowise affected by the manner of the application of the credit, there is no occasion for us to discuss it in this opinion.
Whether the determination of excessive profits made by the Under Secretary of War is increased or decreased by the decision of this Court in the renegotiation proceedings, it will in no way affect the petitioner's tax liability for 1943 which we have here finally determined. Any finding as to excessive profits different from that initially made by the Under Secretary of War will be given final effect by a recomputation of the credit under section 3806. As we have previously stated, until that time, any credit allowed the petitioner under section 3806 will necessarily be tentative, a final credit being determinable only at such time as a final determination of the excessive profits is made.
Reviewed by the Court.
Decision will be entered under Rule 50.