*239 Decisions will be entered under Rule 50.
On October 31, 1944, H. L. McBride conveyed a 1,050.69-acre tract of land to McBride Refining Company, Inc., in which he owned a bare majority of stock, taking a note for the sales price. The company intended to develop the tract into citrus orchards, then sell those orchards at a profit. It expended $ 40,689.84 in 1944 for clearing that land and planting citrus trees on 200 acres thereof; $ 17,214.84 of that sum was spent in clearing 800.69 acres on which no trees were planted. On September 30, 1945, it reconveyed the 800.69 acres to H. L. McBride in accordance with a prior understanding that if any part of the tract were not developed in orchard such part would be so reconveyed for the same price (prorated) as the original purchase price. McBride canceled an appropriate pro rata amount of the company's note and, shortly thereafter, canceled the balance of the note as a donation to the company's surplus.
Held: 1. The conveyance of the 1,050.69-acre tract by McBride to the Refining Company was bona fide and for a business purpose and McBride was not the beneficial owner of any part of that tract between October 31, 1944, and September*240 30, 1945. Consequently, the $ 17,214.84 expended by the Refining Company to clear the 800.69 acres reconveyed to McBride on September 30, 1945, was not spent for McBride's benefit and did not to any extent constitute a dividend taxable to him in 1944.
2. The Refining Company cannot deduct in 1944 the $ 40,689.84 expended in clearing and planting citrus trees on the 1,050.69-acre tract but must capitalize those expenditures as part of the cost of the property. Thompson & Folger Co., 17 T. C. 722, followed. Respondent was not bound by the declaration of policy in Mim. 6030, 1946-2 C. B. 45, that where such orchard development expenditures had been currently deducted in a return filed for a taxable year beginning before July 1, 1946, the deduction would not be disturbed.
*902 The Commissioner determined the following deficiencies in the taxes of the petitioners involved:
| Deficiencies | ||||
| Docket | Petitioner | Year | ||
| No. | Excess | |||
| Income tax | profits tax | |||
| 47338 | H. L. McBride | 1944 | $ 6,270.00 | |
| 47339 | McBride Refining Company, Inc | 1944 | 296.92 | $ 33,900.25 |
The proceedings were consolidated. Some of the adjustments made by the Commissioner as to each petitioner are not contested by petitioners and will be reflected in the Rule 50 computations.
The issues for decision may be stated as follows:
Petitioner McBride Refining Company, Inc. (Docket No. 47339), claimed a deduction of $ 42,007.43 as orchard development expense for 1944. The major portion of such deduction comprises the following items: *903
| Cost of clearing an 800.69-acre section of a 1,050.69-acre tract of | |
| land | $ 17,214.84 |
| Cost of clearing the remaining 250-acre section of the tract | 8,075.00 |
| Cost of planting 8,800 citrus trees on 200 acres of the 250-acre | |
| section | 15,400.00 |
| Total | $ 40,689.84 |
*242 The Commissioner disallowed that $ 40,689.84 deduction. He explained his disallowance of the deduction in a statement attached to the deficiency notice, as follows:
(a) During the year 1944 you expended the sums of $ 25,289.84 and $ 15,400.00 in clearing brush from 1,050.69 acres of land and planting citrus trees on 250 acres of land, respectively. Of the acreage cleared 800.69 acres was [sic] beneficially owned by H. L. McBride et ux and it is held the cost of clearing this land, $ 17,214.84, was for the benefit of Mr. and Mrs. McBride and therefore did not constitute an allowable deduction to you. It is further held the remaining costs incurred by you in the clearing and planting of this land were capital expenditures recoverable through depreciation or upon sale or exchange of the property. Your taxable income has accordingly been increased as follows:
* * * *
| Total increase in income | $ 40,689.84 |
In Docket No. 47338, H. L. McBride petitioner, the Commissioner determined the deficiency by adding to the net income as disclosed by his return, the following items:
| (a) Cattle purchases | $ 8,581.00 |
| (b) Distributions from McBride Refining Company, Inc | 4,535.21 |
*243 Petitioner does not contest adjustment (a). Adjustment (b) is explained by the Commissioner in the deficiency notice, as follows:
(b) During the year 1944 the McBride Refining Company expended the sum of $ 17,214.84 in clearing 800.69 acres of land of which you owned a community one-half. It is held you realized a taxable dividend to the extent of 50% of the corporation's earned surplus as a result thereof and it is further held the cost of clearing this land is a capital expenditure recoverable upon the sale or exchange of the property.
The earned surplus of McBride Refining Company available for dividends as of December 31, 1944 amounted to the sum of $ 9,070.42 and your taxable income for that year has been increased by 50% of that amount, or $ 4,535.21.
By appropriate assignments of error petitioners H. L. McBride and the McBride Refining Company, Inc., contest the Commissioner's adjustments as indicated.
FINDINGS OF FACT.
Some of the facts are stipulated and are so found and incorporated herein by reference.
Petitioner H. L. McBride, hereinafter sometimes referred to as McBride, is an individual whose principal office at all times here material was located at San Antonio, *244 Texas. He filed separate income *904 tax returns on a community property basis for 1944 with the collector of internal revenue for the first district of Texas. His wife in 1944, Dovie Mae McBride, also filed a separate return on a community property basis for that year, but is not a party in these proceedings.
Petitioner McBride Refining Company, Inc., hereinafter sometimes referred to as the Refining Company, is a corporation organized under the laws of the State of Texas. Its principal business is the refining of petroleum products and, during 1944, its principal office was located at Edinburg, Hidalgo County, Texas. It filed its income and excess profits tax returns for the year 1944 with the collector of internal revenue for the first district of Texas.
During all times here material McBride and Dovie Mae McBride owned a fraction over 50 per cent of the Refining Company's stock which entitled them to elect two of the three directors of the company. They served as those two directors and also served as president and secretary, respectively, of the company. The remaining stock of the Refining Company was held in equal amounts by A. B. White and J. F. Whitehurst and entitled*245 them to elect the remaining director. White served as that director and as vice president of the company.
Prior to October 31, 1944, McBride had acquired in connection with his individual ranching operations a 2,350-acre tract of land in Hidalgo County, Texas, about 22 miles north of the Refining Company's plant. On that date he conveyed 1,050.69 acres out of the tract to the Refining Company for a consideration of $ 14,184.32 ($ 13.50 per acre). McBride took a note, bearing 4 per cent interest, from the company for that sales price but agreed to defer collection on the principal thereof until such time as the company's finances would permit.
The Refining Company intended to develop the 1,050.69 acres conveyed to it into citrus orchards, and then sell those orchards at a profit. It was understood at the time of the conveyance, however, that if part of the land was not developed into orchards the undeveloped part would be reconveyed to McBride for the same consideration (appropriately prorated) as was set for the conveyance to the company. 1 Land developers in the Rio Grande Valley at that time were buying land, clearing it, and planting citrus orchards thereon at a total cost*246 of $ 250 to $ 400 per acre, then selling the orchards for as high as $ 1,000 per acre.
On November 15, 1944, the Refining Company entered into a contract with the South Texas Development Company, a partnership in *905 which McBride owned a 60 per cent interest and the Refining Company's auditor owned a 40 per cent interest, to have the 1,050.69-acre tract cleared and improved. There was a heavy growth of mesquite trees, cactus, and other objectionable spiny growth on the tract and the contract provided that the Development Company was (a) to clear and burn all trees, brush, and refuse, root plow, and "float" (i. e., level the ground after the removal of trees and roots by dragging a steel float over it) about 200 acres of the tract for $ 35 per*247 acre and (b) push down the brush, rake, and burn all refuse on the remaining 850.69 acres for $ 21.50 per acre. On the same day, November 15, 1944, the Refining Company contracted with the Texas Produce Company for the latter to plant, during the period January-May 1945, approximately 8,800 citrus trees on the fully cleared and leveled 200-acre section at a cost of $ 1.75 per tree. The aforementioned transactions were recorded in the Refining Company's journal as follows:
| Dr. | Cr | ||
| Other costs -- Land Project: | |||
| Clearing 1,050.69 acres of land and | |||
| floating and planting | |||
| 850.69 acres at $ 21.50 | $ 18,289.84 | ||
| 200 acres at $ 35 | 7,000.00 | ||
| $ 25,289.84 | |||
| 8,800 citrus seedlings | |||
| at $ 1.75 planted | 15,400.00 | ||
| Accounts Payable: | |||
| Texas Produce Company | $ 15,400.00 | ||
| South Texas Development Company | 25,289.84 |
The 8,800 citrus trees were actually planted in April and May 1945. In June 1945, 794 additional citrus trees were purchased from Texas Produce Company for $ 1,389.50 and planted on the tract, thereby increasing the orchard to 250 acres.
On September 30, 1945, the 800.69 acres upon which no citrus trees had been planted were reconveyed by the*248 Refining Company to McBride because by then it had been discovered that good water for irrigation was not obtainable. Prior to the reconveyance that acreage had been partially cleared by the South Texas Development Company, in accordance with the terms of the aforementioned contract, at a cost of $ 17,214.84. The beneficial effects of the clearing operation were evident at the time of the reconveyance and a grassy carpet, which made for better grazing land than the former spiny growth, had begun to develop. As consideration for the reconveyance a pro rata amount of the note given to McBride by the Refining Company was written off and, shortly thereafter, McBride donated the remaining 250 acres to the Refining Company. These transactions were recorded in the Refining Company's journal as follows: *906
| Date | Dr. | Cr. | |
| Sept. 30, 1945 | Debit Notes Payable, H. L. McBride | $ 10,809.32 | |
| Credit Investment -- Land | $ 10,809.32 | ||
| Dec. 31, 1945 | Notes Payable, H. L. McBride | 3,375.00 | |
| Donated Surplus | 3,375.00 | ||
| To credit donated surplus, 250 acres of land at $ 13.50 per acre given | |||
| to company by H. L. McBride. |
Beginning in February 1946, A. B. White endeavored to negotiate*249 a sale of the 250-acre orchard for the Refining Company at prices ranging from $ 90,000 down to $ 47,000. The company was forced to consider selling at a lower price than originally contemplated because the orchard's water supply was uncertain and citrus prices had declined. Before a sale was made, however, the orchard was destroyed by a freeze in January 1949. Sometime subsequent to that date it appears that the 250 acres were reconveyed to McBride. On January 2, 1951, McBride sold 2,590.76 acres of land, part of which was the 1,050.69-acre tract with which we are here concerned, for the total price of $ 115,000.
In its income and excess profits tax return for 1944, the Refining Company deducted as an expense "Cost of seedlings (8,800) and expense of developing orchard, $ 42,007.43." Respondent, as detailed in our preliminary statement preceding these Findings of Fact, disallowed $ 40,689.84 of that deduction. Respondent also determined that the $ 17,214.84 expended by the Refining Company in clearing the 800.69-acre tract reconveyed to McBride on September 30, 1945, was, to the extent of the company's earned surplus of $ 9,070.42 as of December 31, 1944, a dividend to the community*250 of McBride and his then wife and that 50 per cent thereof ($ 4,535.21) was taxable as such to McBride in 1944.
The conveyance of the 1,050.69 acres of land to the Refining Company by McBride on October 31, 1944, was bona fide and McBride was not the beneficial owner of any part of that land between October 31, 1944, and September 30, 1945, at which latter time it was reconveyed to him. Consequently, the $ 17,214.84 spent by the Refining Company in clearing 800.69 of the 1,050.69 acres was not spent for McBride's benefit and did not constitute a dividend to the community of McBride and his then wife to the extent of the company's earnings or profits at the close of 1944. The entire $ 40,689.84 (of which the aforementioned $ 17,214.84 is a part) expended by the Refining Company in 1944 to clear the 1,050.69 acres and plant citrus trees on 200 acres thereof constituted capital expenditures in the development of the land.
OPINION.
Respondent disallowed $ 40,689.84 of a deduction for orchard development expense claimed by the McBride Refining *907 Company, Inc, for 1944. The $ 40,689.84 consisted of (a) $ 17,214.84 expended to clear an 800.69-acre section of a 1,050.69-acre tract*251 of land, and (b) $ 23,475 expended to clear the remaining 250-acre section of the tract and plant citrus trees on 200 acres thereof.
Respondent first contends that the 800.69-acre section was beneficially owned as community property by H. L. McBride and his then wife and, therefore, that the $ 17,214.84 expended in clearing it was not deductible by the company. Moreover, continues respondent, the $ 17,214.84 constituted a taxable dividend to McBride in 1944 to the extent of half the company's earnings or profits available for dividends at the close of that year.
It is respondent's contention that the conveyance of the 1,050.69-acre tract by McBride to the Refining Company was, to the extent of the 800.69-acre section here in question, not bona fide and served no business purpose. He maintains that from the first the parties intended that the 800.69 acres would be reconveyed to McBride after the company cleared them, thereby increasing their value to McBride as grazing land in his individual ranching operations. Clearly the issue here posed is one of fact.
The 1,050.69-acre tract was conveyed by McBride to the Refining Company on October 31, 1944, in order that the latter might *252 develop it into orchards and sell it at a profit. 2 This had proved to be a very profitable endeavor -- other land developers in that area having realized profits of $ 600 per acre and more on sales of orchards developed by them. Certainly the venture contemplated by the company was understandable and reasonable in view of that experience. Moreover, the understanding that if part of the tract was not developed in orchards such part would be reconveyed to McBride for the same consideration (appropriately prorated) as was paid by the company was, we think, a reasonable device protecting the company from loss on resale of the land if its contemplated development project was not completed. Reconveyance of the 800.69 acres to McBride was made on September 30, 1945, primarily because it had been discovered that the land could not be properly irrigated. The evidence clearly shows that to be true.
*253 We think that the transaction was bona fide and served a business purpose; it "is in fact what it appears to be in form." Chisholm v. Commissioner, (C. A. 2) 79 F. 2d 14, 15. The sale of the 800.69 acres was complete, McBride retaining no control over that acreage other than as a stockholder of the Refining Company. It is true that he owned a majority of the company's stock and we have, therefore, subjected the transaction to particular scrutiny, but his majority was only a fraction of 1 per cent and the balance of the company's stock *908 was held by unrelated parties. We conclude, on the basis of the entire record, that these last mentioned factors did not vitiate the transaction, see Chisholm v. Commissioner, supra; Commissioner v. Behan, (C. A. 2) 90 F. 2d 609, that McBride was not the beneficial owner of the 800.69 acres, and that the $ 17,214.84 expended by the Refining Company in clearing that acreage was not for McBride's benefit and was not to any extent a taxable dividend to him in 1944. 3
*254 Respondent next contends that neither the aforementioned $ 17,214.84 nor the balance ($ 23,475) of the $ 40,689.84 expended by the Refining Company for orchard development may be deducted by the company in 1944 since they constituted nondeductible capital expenditures within the meaning of section 24(a) (2) of the Internal Revenue Code of 1939. 4 The Refining Company does not deny that the expenditures in issue were capital in character. See J. H. Sanford, 2 B. T. A. 181. However, it maintains that it had the option to currently deduct those expenditures under the following sentence of Regulations 111, section 29.23(a)-11: "Amounts expended in the development of farms, orchards, and ranches prior to the time when the productive state is reached may be regarded as investments of capital." This sentence appeared in earlier regulations and was therein interpreted by I. T. 1610, II-1 C. B. 85 (1923), and I. T. 1952, III-1 C. B. 139 (1924). 5 The Refining Company is aware that Mim. 6030, 1946-2 C. B. 45 (issued June 20, 1946), revoked I. T. 1610, supra (declaring that the I. T. caused misinterpretation of the above regulation), *255 and further announced that although that regulation does give a taxpayer the option to capitalize "expenditures incurred during the period of development which might otherwise be deductible as current expenses, [it] * * * does not permit capital items to be treated as ordinary and necessary business expenses." (Emphasis added.) But the company *909 argues that Mim. 6030 is incorrect in its interpretation of the regulation and, even if correct, cannot be applied retroactively to 1944.
*256 Our Court had occasion to deal with this precise question in Thompson & Folger Co., 17 T. C. 722, where, after a thorough analysis, we concluded with the following statement which is alike applicable to the instant case:
the petitioner's counsel relies on what he claims was the established and accepted interpretation of the regulation for many years, which position he feels is supported by I. T.'s 1610 and 1952, supra. He takes rather violent issue with the interpretation of the regulation appearing in Mim. 6030 * * *, supra, as being contrary to the regulation and as having no retroactive force and effect. His position, in our opinion, is not well taken and must be rejected. The interpretation of the regulation, as set forth in considerable detail in Mim. 6030 * * * is in complete harmony with our interpretation previously stated herein. As for the prior interpretation claimed, I. T. 1610 goes no further than to say that expenditures which, under the regulation, "may be regarded as investments of capital" may, at the option of the taxpayer, be deducted or capitalized, and I. T. 1952 merely states that where the taxpayer has capitalized*257 expenditures which, under the regulation in question, "may be regarded as investments of capital," he may not thereafter change his mind and obtain a refund of the income tax paid by changing his position and claiming the expenditures as business expense deductions. As is true of the regulation itself, neither of the I. T.'s may in our opinion be read as saying that expenditures, capital in character, as are those in this case, "may be regarded as ordinary and necessary expenses." Furthermore, the proposition that I. T.'s, Mimeographs, and other office rulings do not have the stature of a regulation is too well established to require discussion. And even if the I. T.'s in question were as petitioner contends, they would, as a matter of course, have to give way to a proper interpretation and application of the law, whether in the form of the statute itself or the duly promulgated regulation. And that would be so regardless of whether the overruling of the I. T.'s was prospective or retroactive in effect.
The Refining Company next relies upon the concluding declaration of policy in Mim. 6030, supra, to the effect that where,
with respect to taxable years beginning prior to *258 July 1, 1946, taxpayers have, in their returns, treated the above-mentioned [capital] * * * expenditures as ordinary and necessary expenses, such treatment will not be disturbed, and the rules stated in this mimeograph with respect to [capital] * * * expenditures will be applied only with respect to such costs incurred for taxable years beginning on or after July 1, 1946. * * * 6
The company correctly contends, we think, that its treatment of orchard development expenditures for 1944 falls within the ambit of the above declaration of policy. It then argues that respondent, by disallowing the 1944 deduction has retroactively changed that administrative policy, which is improper, and has treated it unequally vis-a-vis other taxpayers who have been permitted to take advantage of that policy.
*259 *910 The Refining Company's position has no legal validity. We have already seen that the correct interpretation of the regulatory provision in question, and of the underlying statute, prevents deduction of the expenditures here in issue, and that application of the correct interpretation to taxable years ending prior to its announcement in Mim. 6030 does not constitute unallowable retroactivity. Thompson & Folger Co., supra; Manhattan General Equipment Co. v. Commissioner, 297 U.S. 129">297 U.S. 129. As regards the policy statement with which Mim. 6030 is concluded, it is no more than an administrative declaration by respondent's predecessor (by whom it was promulgated) to the effect that he, in his discretion, has determined not to enforce the revenue laws in the situation described. The cases are clear that such a departmental ruling has no binding or legal effect and may be changed, or ignored, either prospectively or retroactively. Biddle v. Commissioner, 302 U.S. 573">302 U.S. 573; United States v. Bennett, (C. A. 5) 186 F. 2d 407; Langstaff v. Lucas, (W. D., Ky.) 9 F. 2d 691,*260 affirmed per curiam (C. A. 6) 13 F. 2d 1022, certiorari denied 273 U.S. 721">273 U.S. 721; Hirshon v. United States, (Ct. Cl.) 116 F. Supp. 185">116 F. Supp. 185; Southern Maryland Agricultural Fair Association, 40 B. T. A. 549, and many others. This Court long ago said in James Couzens, 11 B. T. A. 1040, 1156:
as to the effect of the departmental orders, we are of opinion that they may not go so far as either to impose upon a taxpayer more than his statutory tax or to relieve him from its full burden. Congress, as we have said, has prescribed a system for closing cases by limitation, agreement, or legal proceeding, and this must be held to be all comprehensive. It does not admit the view that the Commissioner may by regulation or ruling in a particular case close it from further consideration. We have seen * * * that his ruling does not foreclose the taxpayer, and it is but reasonable to hold the door open as well to the United States.
And, more recently, in Keystone Automobile Club, 12 T.C. 1038">12 T.C. 1038, 1047, affd. (C.A. 3) 181 F. 2d 402:*261 "No basis exists for limiting the action of respondent under the doctrine of estoppel where appropriate enforcement of the law requires a change of position on his part."
On the strength of the foregoing authorities, we hold that the Refining Company may not currently deduct the $ 40,689.84 incurred in orchard development expenditures in 1944, but must capitalize those expenditures as additional costs of the property. This additional cost of the property to the Refining Company is to be recovered in the ways and manner provided by the applicable statutes.
Decisions will be entered under Rule 50.
Footnotes
1. This fact was established by a sworn statement which A. B. White, deceased at the time of the hearing, made to the collector of internal revenue on April 20, 1949, and which the parties herein stipulated would represent White's testimony were he available to testify.↩
2. Although McBride testified that it was the company's intent to construct a recycling plant upon part of the tract, we have found, based on the sworn statement of the company's vice president, A. B. White (deceased), which statement was accepted in evidence, that the company primarily intended to develop the tract into orchards.↩
3. We express no opinion as to the tax consequences of the reconveyance of the 800.69 acres to McBride on September 30, 1945, since that tax year is not before us.↩
4. SEC. 24. ITEMS NOT DEDUCTIBLE.
(a) General Rule. -- In computing net income no deduction shall in any case be allowed in respect of
* * * *
(2) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate, except expenditures for the development of mines or deposits deductible under section 23 (cc); ↩
5. I. T. 1610.
Under article 110, Regulations 62, taxpayer has option of charging amounts expended in development of orchards prior to time productive state is reached as expense or capitalizing them.I. T. 1952.
A taxpayer who exercised his option for the years 1918, 1919 and 1920 in accordance with article 110, Regulations 45, by capitalizing the expenditures of bringing his ranch property to a productive state instead of deducting the amounts as business expenses is not entitled to file claims for refund based on the fact that he now desires to treat the amounts as business expenses for those years.↩
6. This statement of policy was clarified in Mim. 6030 (Supplement 1), 1948-1 C. B. 42↩ (issued January 8, 1948), but that clarification has no particular pertinence to the facts herein and, therefore, need not be discussed.