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Commissioner of Internal Revenue v. Security Flour Mills Co.

March 6, 1943

COMMISSIONER OF INTERNAL REVENUE
v.
SECURITY FLOUR MILLS CO.; SECURITY FLOUR MILLS CO. V. COMMISSIONER OF INTERNAL REVENUE.



On Petitions to Review the Decision of the United States Board of Tax Appeal.

Bratton

Before PHILLIPS, BRATTON, and HUXMAN, Circuit Judges.

BRATTON, Circuit Judge.

This proceeding presents questions relating to income and excess profits taxes. The taxpayer was engaged in the maunfacture and sale of flour, and was subject to the processing tax levied under the Agricultural Adjustment Act of 1933, 48 Stat. 31, 7 U.S.C.A.§ 601 et seq. During the period which is material here more than half of its sales of flour were made under the Miller's Federation Uniform Sales Contract. The sales were at a stated price per barrel which included the usual items of cost, a normal profit, and a sufficient amount to cover the processing tax. The invoices reflected the contract price but did not show the tax as a separate item. The taxpayer secured a temporary injunction, effective from May 1, 1935, restraining the further collection of the tax, on condition that it file informational returns and deposit in a designated bank a sum equal to the amount of the tax computed according to the act. Up to Dcecember 1, 1935, the taxpayer deposited in the bank sums aggregating $93,974.40; and it accrued on its books as a liability for the processing tax, but did not pay either to the collector or the depository, the sum of $9,896.66, plus the additional item of $1,183.64, representing a reserve for possible increases in the tax for prior years. In January, 1936, the processing tax provisions in the act were held invalid, United States v. Butler, 297 U.S. 1, 56 S. Ct. 312, 80 L. Ed. 477, 102 A.L.R. 914; and in February, thereafter, the sum deposited in the bank was returned to the taxpayer. Certain vendees of flour sought to intervene in the injunction proceeding and assert right in the impounded funds, but the taxpayer resisted and the petitions were denied. After the impounded funds had been returned to the taxpayer, certain vendees instituted suits against it to recover amounts equal to the processing tax on flour purchased while the injunction was in force, but the taxpayer defended and the actions were finally dismissed. In 1936, the taxpayer credited the money which the bank returned to it to an account on its books designated "Reserve for Processing Tax, Claims, etc." The account bears credits aggregating $105,254.70, and debits of an equal amount, the last debit being a transfer to surplus of $30,289.99, made in June, 1939. In 1936, 1937, and 1938, the taxpayer disbursed to certain of its vendees on shipments of flour made while the injunction was in effect sums aggregating $45,865.90. No refunds were made to the other purchasers during that period. The taxpayer kept its books and made its tax returns on the accrual basis. In its return for 1935, it made deductions which included the funds impounded in the depository and the funds accrued on its books as processing taxes but not impounded or paid to the collector. The Commissioner disallowed the deductions of these items. The Board of Tax Appeals ruled that the sums which the taxpayer received from its vendees to cover the processing tax constituted gross income for the year 1935, and that the amounts didbursed in 1936, 1937, and 1938, should be carried back and allowed as deductions for the year 1935. The Commissioner sought review from that part of the decision allowing the deductions in that manner.

Like all other revenue acts enacted since the adoption of the Sixteenth Amendment, the Act of 1934, 48 Stat. 680, assessed the taxes on the basis of annual periods, either the calendar year, or, at the election of the taxpayer, a fiscal year; and section 23(a), 26 U.S.C.A. Int. Rev. Code, § 23(a)(1), authorized the deduction from gross income of all ordinary and necessary expenses paid or incurred during the taxable year in carring on any trade or business.

The production of revenue ascertainable and payable at fixed intervals is the essence of any feasible system of taxation. It is the essence itself of any general scheme for taxing income as a means of producing a regular flow of income. Burnet v. Sanford & Brooks Co., 282 U.S. 359, 51 S. Ct. 150, 75 L. Ed. 383. Where accounts are kept and returns made on the accrual basis, income is to be accounted for in the year in which it is realized, even though not actually received; and deductions are to be taken in the year in which the items deducted are incurred, whether actually paid or not. Brown v. Helvering, 291 U.S. 193, 54 S. Ct. 356, 78 L. Ed. 725. Revenue received under claim of right wihout restriction in respect of its use or disposition constitutes taxable income, even though the one receiving it may thereafter be adjudged liable to restore it or its equivalent. North American Oil Consolidated v. Burnet, 286 U.S. 417, 52 S. Ct. 613, 76 L. Ed. 1197; Brown v. Helvering, supra; Saunders v. Commissioner, 10 Cir., 101 F.2d 407; London-Butte Gold Mines Co. v. Commissioner, 10 Cir., 116 F.2d 478. And ordinarily where the accrual system is used in keeping books of account and making income tax returns, deductions may be claimed for the year the accrual of liability occurred, or not at all, even though the transaction or transactions giving rise to the accrual of liability may have taken place in an earlier year. Lucas v. Ox Fibre Brush Co., 281 U.S. 115, 50 S. Ct. 273, 74 L. Ed. 733. Losses suffered or expenses accrued in a later year may be deducted from earnings in that year. But the tax on the income of a given year may not be withheld or diminished because losses may subsequently occur or expenses be later accured. Heiner v. Mellon, 304 U.S. 271, 58 S. Ct. 926, 82 L. Ed. 1337.

Here the taxpayer received from its vendees amounts equal to the processing tax on flour sold during the period in which the injunction was in force. It made no promise or contractual obligation to repay or refund any or all thereof in the event the act was declared unconstitutional, or otherwise. It stated to some purchasers of flour that it would treat them fairly, but it carefully and painstakingly avoided making any binding commitment to restore to them any of the fund or its equivalent. It was not legally liable to them for any of it, Moundridge Milling Co. v. Cream of Wheat Corp., 10 Cir., 105 F.2d 366; and after the declared invalidity of the processing tax statute, it bore no liability to the fiscus for any part of such fund, Rickert Rice Mills v. Fontenot, 297 U.S. 110, 56 S. Ct. 374, 80 L. Ed. 513. But it became entitled to the money and actually received it in 1935 under claim of right without legal restriction as to its use and disposition, and it therefore constituted taxable income in that year. North American Oil Consolidated v. Burnet, supra; Brown v. Helvering, supra; Saunders v. Commissioner, supra.

Section 43 of the Revenue Act, supra, 26 U.S.C.A. Int. Rev. Code, § 43, is relied upon as authorizing the relation back of the amounts disbursed to the year 1935. The pertinent part of the section provides that "deductions and credits * * * shall be taken for the taxable year in which 'paid or accrued' or 'paid or incurred', dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions or credits should be taken as of a different period." A substantially identical provision first appeared as section 200(d) of the Revenue Act of 1924, 26 U.S.C.A. Int. Rev. Code, § 43, and is to be found in all later revenue acts. In explaining the provision in the Act of 1924, the report of the Committee on Ways and Means of the House stated:

"The Revenue Act of 1921 * * * authorizes the Commissioner to allow the deduction of losses in a year other than that in which sustained when, in his opinion, it is necessary to clearly reflect the income. The proposed bill extends that theory to all deductions and credits.The necessity for such a provision arises in cases in which a taxpayer pays in one year interest or rental payments or other items for a period of years. If he is forced to deduct the amount in the year in which paid, it may result in a distortion of his income which will cause him to pay either more or less taxes than he properly should."

The report of the Senate Committee on Finance was identical. These reports make it clear that the legislative intent and purpose of the "unless" provision was to authorize the exception to the general rule in cases in which the taxpayer pays in one year interest, or rental, or other items for a period of years, and to other instances of that character, in order to prevent distortion of income of the taxpayer. It is manifest that Congress had in mind for application of the provision only instances in which a taxpayer receives income or makes expenditures in one year which are attributable to or related to business operations extending over a number of years. The distortion in income sought to be avoided is that which would result from charging a taxpayer with income received in a single year but in fact earned over a period of years, or permitting him to take in one year deductions actually attributable to operations extending through two or more years. To permit that would not fairly reflect annual income. Instead it would amount to distortion of income. The provision comes into operative play in instances of that kind. It was never intended to go beyond that scope. These transactions were not of that kind. All of the income was fully earned in 1935. No part of it extended over a period of years. The expenditures were not for interest, or rental, or other items of that kind covering a period of years. They were not in liquidation of any previously accrued legal obligation. They were voluntarily made for the primary purpose of retaining the good will of customers; and the liability was accrued and discharged, all after 1935. In short, neither the income nor the respective disbursements were attributable to operations extending over two or more years. Instead each was effected and completed in a single year. For these reasons the taxpayer does not bring itself within the "unless" clause in the statute. The amounts disbursed were deductible from gross income in 1936, 1937, and 1938, respectively; but not from that of 1935. North American Oil Consolidated v. Burnet, supra.

The taxpayer places strong reliance on Helvering v. Cannon Valley Milling Co., 8 Cir., 129 F.2d 642. Assuming for the moment that disbursements of this kind may be related back in certain circumstances, though we think otherwise, the two cases are distinguishable. There apparently all the facts were before the court, and it was held that unless the disbursements were related back income would be distorted with resulting injustice to the taxpayer. Here the return of the taxpayer for 1937 disclosed a net loss, computed by including in the deductions claimed a sum representing the amounts paid in that year to vendees of flour. But the returns for 1936 and 1938 were not introduced in evidence, and there was no showing whatever in respect of gross or net income for those years. Therefore, considering 1935, 1936, 1937, and 1938, together, as they should be considered, there is no basis for the conclusion that the deductions must be related back in order to clearly reflect the income and deductions, and to prevent distortion of income, within the meaning of the statute.

Title III of the Revenue Act of 1936, 49 Stat. 1648, 26 U.S.C.A. Int. Rev. Code, § 700 rt seq., imposes a tax on unjust entrichment arising our of the nonpayment of processing taxes, the burden of which has been shifted to other; and Title VII, 7 U.S.C.A. §§ 623, 644 et seq., authorizes refunds for amounts paid as processing taxes. Section 506 of Title III provides that one who is liable for unjust enrichment taxes and who also has a claim for an amount paid as processing taxes may apply to the Commissioner for an adjustment of the two together; that the Commissioner may in his discretion consider them in that manner; that he may enter into a written agreement with the person for the settlement of the case by payment or refund as may be specified in the agreement; and that the agreement shall be a final settlement of the liability for taxes and of the claim for refund, except in cases of fraud, malfeasance, or misrepresentation of material fact. The taxpayer filed a claim for refund of amounts paid as processing taxes before the date on which the injunction became effective. The Commissioner and the taxpayer proceeded under section 506 and reached a settlement of the liability for unjust enrichment taxes and of the claim for refund. The signed agreement provided that the whole matter should be finally settled by the taxpayer making payment of $16,405.33, and that amount was paid. The Board found that the computation made in connection with the agreement disclosed a net unjust enrichment tax liability for 1935, 1936, and 1937 of $36,880.21, a refund due of $20,474.88, and a net tax payable of $16,405.33, of which $2,649.25 pertained to a refund of processing taxes for 1935, and was allowed by the Commissioner in determining the deficiency. The Board concluded that such sum should be restored to income for the year 1935; and the taxpayer perfected a separate appeal from that part of the decision.

The question calls for little discussion. Section 506 is a clear mandate that an agreement entered into under its provisions shall be and constitute a finual settlement of the liability for the tax and of the claim for refund, unless there was fraud, malfeasance, or misrepresentation of a material fact in connection with its execution. There is no suggestion that any lack of good faith occurred in connection with the execution of this agreement. The contract was a final settlement. And in view of the plain language of the statute, we fail to see any ...


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