*3101 1. The amount of the award of the New York State Compensation Insurance Commission on account of a death from accident on the petitioner's property is not necessarily properly accrued upon the petitioner's books where it appears that an appeal was taken from the Commission's decision which decision was sustained in the following year.
2. A railroad had income where after Federal control the Director General, having failed to return materials and supplies equal in quantity, quality and relative usefulness to that of the materials and supplies which he received, accounted for the shortage at prices prevailing at the end of Federal control in an amount in excess of the cost of the materials and supplies which were not returned.
*1154 The Commissioner determined a deficiency of $4,487.79 for the calendar year 1920 and a deficiency of $56,503.74 for the calendar year 1921. The petitioner instituted this proceeding for the redetermination of these deficiencies and alleged three errors as follows:
(a) The Commissioner has*3102 erroneously held that a deduction of $10,644.12 representing a liability for injury to persons should be deducted in 1921 instead of 1920 when such item was accrued on the books of the taxpayer.
(b) The Commissioner has erroneously held that the taxpayer derived a profit of $121,750.45 from the taking and seizure of materials and supplies inventory by the Director General on behalf of the United States and replacement thereof in specie or its money equivalent.
*1155 (c) The Commissioner has erroneously held that the taxpayer derived a profit amounting to $141,251.60 from an allowance by the Director General, in discharge of the liability of the United States to make expenditures during the period of Federal control for the maintenance of the railroad properties of the taxpayer so as to return such properties at the conclusion of such Federal control in as good condition as when taken over by the United States.
The respondent has conceded the error as set forth in paragraph (c) above.
By an amended answer the respondent alleged that the correct deficiency for the year 1920 is $127,518.49, for the reason that the petitioner had never reported as income $384,750.94, *3103 an amount awarded to the petitioner to make good a guarantee under the terms of the "Transportation Act, 1920." The respondent thereafter conceded that this allegation was improperly made and that the petitioner had not only accrued on its books and reported as income the sum of $384,750.94, which was actually awarded to the petitioner, but had accrued on its books and reported as income $2,085.02 in excess of this amount for the year 1920, by which excess income for 1920 should now be reduced.
At the hearing, counsel for the respondent made the following claim under the provisions of section 274(e) of the Revenue Act of 1926:
The respondent now claims as an alternative to the adjustment of income for the year 1921 made in the deficiency letter on account of materials and supplies, that if the Board should find that no income was realized in 1921 from the payment for the shortage in materials and supplies, then income on account of such payment for shortage in materials and supplies was realized in the year 1920 and that the taxable income for the year 1920 should be increased with the resulting effect in tax reflected in the Board's findings and orders.
The parties entered*3104 into a stipulation in regard to many of the facts.
FINDINGS OF FACT.
The petitioner is a corporation organized under the laws of the States of New York and New Jersey, with principal offices at 60 Main Street, Warwick, N.Y. It is engaged in the business of common carrier and its system of accounting is that prescribed by the Interstate Commerce Commission. Its tax returns for the years 1920 and 1921 were filed in the Fourteenth New York Collection District.
During the year 1920 a man was killed in a railway accident on the petitioner's property. In the same year the New York State Compensation Insurance Commission awarded the widow the amount of $10,614.12. An appeal was taken from the Commission's decision, which was, however, sustained in 1921. The petitioner accrued the amount of the award of the Compensation Commission on its *1156 books in 1920 and claimed it as a deduction in its return for 1920. The respondent has held that this amount should be deducted in the year 1921.
By a proclamation dated December 26, 1917, the President of the United States, acting under the powers conferred on him by the Constitution and laws of the United States, by the joint*3105 resolution of the Senate and House of Representatives, bearing date of April 6, and December 7, 1917, respectively, and particularly under the powers conferred by section (1) of the Act of Congress approved August 29, 1916, entitled "An Act making Appropriation for the Support of the Army for the fiscal year ended June 30, 1917, and for other purposes," took possession and assumed control at 12 o'clock noon, December 28, 1917, of certain railroads and systems of transportation, including the railroad and transportation system of the petitioner, and directed that the possession, control, operation and utilization of the transportation systems thus taken should be exercised by and through a Director General of Railroads (hereinafter refered to as the "Director General").
Attached to the aforesaid proclamation of December 26, 1917, was a statement personally signed by the President, which was in part as follows:
I have exercised the powers over the transportation systems of the country which were granted me by the Act of Congress of last August because it has become imperatively necessary for me to do so. This is a war of resources no less than of men, perhaps even more than of*3106 men, and it is necessary for the complete mobilization of our resources that the transportation systems of the country should be organized and employed under a single authority and a simplified method of coordination which have not proved possible under private management and control.
* * *
Investors in railway securities may rest assured that their rights and interests will be as scrupulously looked after by the Government as they could be by the directors of the several railway systems. Immediately upon the reassembling of Congress I shall recommend that these definite guaranties be given: First, of course, that the railway properties will be maintained during the period of Federal control in as good repair and as complete equipment as when taken over by the Government; and, second, that the roads shall receive a net operating income, equal in each case to the average net income of the three years preceding June 30, 1917; and I am entirely confident that Congress will be disposed in this case, as in others, to see that justice is done and full security assured to the owners and creditors of the great systems which the Government must now use under its own direction*3107 or else suffer serious embarrassment.
Subsequently, the Congress of the United States, by an Act approved March 21, 1918, generally designated as and hereinafter called "The Federal Control Act," authorized the President to enter into agreements with the companies owning the railroads and systems *1157 thus taken over for the maintenance and upkeep of the same during the period of Federal control and for the determination of the rights and obligations of the parties to the agreement arising from or out of such Federal control, including the compensation to be received or guaranteed, and for other purposes.
The Federal Control Act provided in part as follows:
That the President, having in time of war taken over the possession, use, control and operation (called herein Federal control), of certain railroads and systems of transportation (called herein carriers), is hereby authorized to agree with and to guarantee to any such carrier making operating returns to the Interstate Commerce Commission that during the period of such Federal control it shall receive as just compensation an annual sum payable from time to time in reasonable installments for each year, and pro rata*3108 for any fraction of a year, of such Federal control not exceeding a sum equivalent, as nearly as may be, to its average annual railway operating income for the three years ended June 30, 1917.
* * * The average annual railway operating income shall be ascertained by the Interstate Commerce Commission and certified by it to the President. Its certificate shall, for the purpose of such agreement, be taken as conclusive of the amount of such average annual railway operating income.
* * *
Every such agreement shall also contain adequate and appropriate provisions for the maintenance, repair, renewals, and depreciation of the property, for the creation of any reserves or reserve funds found necessary in connection therewith, and for such accounting and adjustments of charges and payments, both during and at the end of Federal control as may be requisite in order that the property of each carrier may be returned to it in substantially as good repair and in substantially as complete equipment as it was in at the beginning of Federal control, and also that the United States may, by deductions from the just compensation or by other proper means and charges, be reimbursed for the cost*3109 of any additions, repairs, renewals, and betterments to such property not justly chargeable to the United States; in making such accounting and adjustments, due consideration shall be given to the amounts expended or reserved by each carrier for maintenance, repairs, renewals, and depreciation during the three years ended June thirtieth, nineteen hundred and seventeen, to the condition of the property at the beginning and at the end of Federal control and to any other pertinent facts and circumstances.
On March 29, 1918, the President, acting under the aforesaid Federal Control Act and all other powers him thereto enabling, by proclamation authorized the Director General, either personally or through such agencies or divisions of persons as he might appoint for such purposes, to agree with the carriers, or any one of them, upon the amounts to be paid such carriers for the assumption of control, use, maintenance and operation of such railroad and transportation systems and for the return of such properties to the carriers at the conclusion of such Federal control.
On March 26, 1919, the taxpayer corporation entered into an agreement with the Director General, acting for the said*3110 United States, to provide for the control, maintenance, use and operation of the *1158 railroad and transportation system of the petitioner and for the compensation for use and operation thereof, for the maintenance thereof and the return thereof at the conclusion of such Federal control.
The agreement of March 26, 1919, provided in part as follows:
Sec. 5. (a) During the period of Federal control the Director General shall, annually, as nearly as practicable, expend and charge to railway operating expenses, either in payments for labor and materials or by payments into funds, such sums for the maintenance, repair, renewal, retirement, and depreciation of the property described in paragraph (a) of section 2 hereof as may be requisite in order that such property may be returned to the Company at the end of Federal control in substantially as good repair and in substantially as complete equipment as it was on January 1, 1918; Provided, however, That the annual expenditure and charges for such purposes during the period of Federal control on such property and the fair distribution thereof over the same, or the payment into funds of an amount equal in the aggregate (subject*3111 to the adjustments provided in paragraph (c) and to the provisions of paragraph (e) of this section) to the average annual expenditure and charges for such purposes included under the accounting rules of the Commission in railway operating expenses during the test period, less the cost of fire insurance included therein, shall be taken as a full compliance with the foregoing covenant.
* * *
Sec. 7. (a) The annual compensation guaranteed to the Company under section 1 of the Federal control act shall be the sum of five hundred and nineteen thousand three hundred and seventy-one dollars and thirteen cents ($519,371.13) during each year and pro rata for each fractional part of a year of Federal control, subject, however, to any increase or decrease in the standard return hereafter made by the Commission as provided in paragraph (e) of the preamble of this agreement.
* * *
Sec. 9. (a) At the end of Federal control all the property described in paragraph (a) of section 2 hereof shall be returned to the Company, together with all repairs, renewals, additions, betterments, replacements, and road extension thereto which have been made during Federal control, except as any part thereof*3112 may have been destroyed or retired and not replaced, in which case the provisions of section 5 hereof shall govern and except that the Director General shall not be obliged to restore or replace property destroyed or damaged by the acts of public enemies.
(b) At the end of Federal control the Director General shall return to the Company all uncollected accounts received by him from the Company and also materials and supplies equal in quantity, quality, and relative usefulness to that of the materials and supplies which he received and to the extent that the Director General does not return such materials and supplies he shall account for the same at prices prevailing at the end of Federal control. To the extent that the Company receives materials and supplies in excess of those delivered by it to the Director General it shall account for the same at the prices prevailing at the end of Federal control, and the balance shall be adjusted in cash.
The Congress of the United States, by Act approved February 28, 1920, entitled the Transportation Act, directed that Federal control "terminate at 12.01 A.M., March 1, 1920; and the President shall *1159 then relinquish possession*3113 and control of all railroads and systems of transportation then under Federal control and cease the use and operation thereof." This statute further authorized the President to make agreements in final settlement of all matters arising out of Federal control.
In accordance with the terms of this Act of Congress, the President, on March 1, 1920, relinquished possession of the railroad system of the petitioner and turned back to the petitioner all the properties then comprising such system.
Following the relinquishment and turning back of the properties under Federal control, the petitioner filed with the Director General various claims setting out amounts appearing on its books as due to it by the Director General and from it to the Director General and, in addition thereto, certain other amounts not on its books but claimed by it to be due from the Director General.
There were controversies on the different claims filed by the petitioner corporation. The office of the Director General had set up on its books as of December 31, 1920, the amounts which that office deemed were due the corporation on the various items in dispute. The net balance of these accounts was $153,189.40*3114 due the corporation, instead of $512,708.51 as claimed by the petitioner. Compensation for the use of the properties had been determined by the standard contract and the parties were agreed on the open accounts representing amounts which had been accrued for advances and payments during Federal control. The items in dispute were the amounts necessary, under sections 5(a) and 9(b) of the contract, to make good the deficiency in material and supplies inventory, depreciation on equipment, property retired and not replaced, and undermaintenance of ways and structures, and equipment. A conference was held in Washington between the president of the petitioner corporation and his associates and the Director General and his associates for the purpose of reaching a final settlement of all the matters in dispute. After considerable discussion of the items in dispute the Director General offered the sum of $225,000 in final settlement of all matters arising out of Federal control, including the items then under controversy. The president of the petitioner company accepted the lump sum offer. Nothing was said as to specific items in dispute and no agreement was reached on the amounts in*3115 dispute.
Following this conference, and under date of March 3, 1921, the Director General of Railroads, acting on behalf of the United States, and the petitioner corporation entered into a formal, final settlement agreement in accordance with the agreement reached in conference. The pertinent provisions of this agreement were as follows:
*1160 The Lehigh & Hudson River Railway Company hereby acknowledges payment of the sum of two hundred and twenty-five thousand dollars ($225,000.00) by the said Director General, the receipt whereof is hereby acknowledged, in full satisfaction and discharge of all claims, rights, and demands, of every kind and character, which the said Company now has or hereafter may have or claim against the Director General, or any one representing or claiming to represent the Director General, the United States, or the President, growing out of or connected with the possession, use, and operation of the Company's property by the United States during the period of Federal control, or out of the contract between the parties dated the 26th day of March, 1919; and the said Company hereby acknowledges the return to and receipt by it of all its property*3116 and rights which it is entitled to, and further acknowledges that the Director General has fully and completely complied with and satisfied all obligations on his part, or on the part of the United States, or the United States Railroad Administration, growing out of Federal control.
The purpose and effect of this instrument is to evidence a complete and final settlement of all demands, of every kind and character, as between the parties hereto growing out of the Federal control of railroads, save and except that the following matters are not included in this adjustment and are not affected thereby: * * *
The Director General at the time of the settlement withheld from the petitioner official information as to his settlement figure. The general accountant of the petitioner corporation, in order to balance his books against the settlement figure of $225,000, thereafter unofficially obtained the Director General's settlement figures for some of the items from employees of the Railroad Administration. The petitioner later obtained all of these figures which indicate that the Director General allowed his accounts to stand the same as before the final settlement agreement except that*3117 he reduced the amount due him for over-maintenance of equipment from $95,558 to $23,747.40 and increased the allowance to the company for a shortage of materials and supplies from $234,841.58 to $247,744.68, an increase of $12,903.10, which increase he offset by adding $12,903.10 to "Other Items due from Corporation" as "Adjustment of Prices on M&S used in A&B work."
The action of the Director General in making a lump sum settlement in this case and in withholding certain specific details from the carriers was in accordance with his general policy of not making any specific allowance or agreement but to settle the cases as promptly and as cheaply as possible under the terms of the Federal Control Act and the standard contract.
Pursuant to the provisions of subsection (a) of section 7, supra, of the agreement of March 26, 1919, the petitioner accrued on its books compensation as follows:
| 1918 | $519,371.13 |
| 1919 | 519,371.13 |
| 1920 (2 months) | 86,561.86 |
| Total | 1,125,304,12 |
*1161 The above amounts were reported on the income and profits-tax returns filed for the aforesaid years, including 1920, and the respondent made no adjustment of the amount reported*3118 for 1920.
This amount of $86,561.86 was determined by taking 2/12 of $519,371.13. This amount was subsequently adjusted to 60/366 of $519,371.13, or $85,142.81, compensation for the months of January and February, 1920. The difference between the amount accrued and reported as income for 1920 and the amount as adjusted, or $1,419.05, was charged against income in 1921 on the books of the petitioner and so reported in its income and profits-tax returns for 1921. The respondent did not disturb this charge.
Included in the assets and properties taken over by the Director General as of January 1, 1918, was an inventory of "Materials & Supplies" having a total cost of $336,700.71. Included in the assets and properties turned back to the petitioner on March 1, 1920, at the conclusion of Federal control, was an inventory of "Materials & Supplies" having a total cost of $223,609.58. The inventory so turned back was not sufficient to replace an inventory equal in quantity, quality and relative usefulness to that of the inventory taken over.
The following is a summary of the final claim of the petitioner, the Administration books as of December 31, 1920, the difference between*3119 the two, and the final settlement allowance as reflected by the books of the Director General:
| Corporate claim as of Dec. 31, 1920 | Administration books as of Dec. 31, 1920 | Difference | |
| Due to corporation | |||
| Compensation | $1,125,304.12 | $1,123,885.07 | $1,419.05 |
| Less advances, loans, etc., to Feb. 15, 1921 | 1,365,770.00 | 1,355,770.00 | |
| 1 240,465.88 | 1 241,884.93 | 1 1,419.05 | |
| Rental interest on completed A&B | 3,127.00 | 3,127.00 | |
| Cash on hand Dec. 31, 1917 | 385,790.60 | 385,790.60 | |
| Agents and conductors balance Dec. 31, 1917 | 7,507.10 | 7,507.10 | |
| Assets Dec. 31, 1917, collected | 673,840.94 | 673,840.94 | |
| Revenue prior to Jan. 1, 1918 | 53,970.81 | 53,970.81 | |
| Interest other than rental interest | 64,074.05 | 26,520.88 | 37,553.17 |
| 944,717.62 | 908,872.40 | 35,845.22 | |
| Due from corporation | |||
| Additions and betterments | 109,786.74 | 109,786.74 | |
| Liabilities Dec. 31, 1917, paid | 851,794.40 | 851,794.40 | |
| Corporate transactions | 237,051.36 | 237,051.36 | |
| Expense prior to Jan. 1, 1918 | 81,560.91 | 81,560.91 | |
| Total | 1,280,193.41 | 1,280,193.41 | |
| Balance due from corporation | 335,475.79 | 371,321.01 | 35,845.22 |
| Other items due corporation | |||
| Material and supplies (excess) | 248,172.70 | 234,841.58 | 13,331.12 |
| Depreciation on equipment | 201,773.14 | 188,384.00 | 13,389.14 |
| Equipment retired | 46,306.27 | 30,647.50 | 15,658.77 |
| Road property retired and not replaced | 1,454.17 | 1,196.33 | 257.84 |
| Total | 497,706.28 | 455,069.41 | 42,636.87 |
| Other items due from corporation - None | |||
| Balance due to corporation on other items | $497,706.28 | $455,069.41 | $42,636.87 |
| Balance due to corporation | 162,230.49 | 83,748.40 | 78,482.09 |
| Maintenance | |||
| Maintenance of way and structures - Under | 220,667.71 | 164,999.00 | 55,668.71 |
| Maintenance of equipment - Under | 129,810.31 | ||
| Maintenance of equipment - Over | 95,558.00 | 225,368.31 | |
| Balance due to corporation on maintenance | 350,478.02 | 69,441.00 | 281,037.02 |
| Net balance due to corporation | 512,708.51 | 153,189.40 | 359,519.11 |
| Due to corporation | |
| Claim as settled | |
| Compensation | $1,123,885.07 |
| Less advances, loans, etc | 1,365.770.00 |
| 241,884.93 | |
| Rental interest on completed A&B | 3,127.00 |
| Balance due from corporation | 238,757.93 |
| Open accounts due to corporation | |
| Cash on hand, Dec. 31, 1917 | $385,790.60 |
| Agent's and conductor's balance, Dec. 31, 1917 | 7,507.10 |
| Assets, Dec. 31, 1917 - Collected | 673,840.94 |
| Revenue prior to Jan. 1, 1918 | 53,970.81 |
| Total | 1,121,109.45 |
| Open accounts due from corporation | |
| Liabilities, Dec. 31, 1917, paid | $851,794.40 |
| Corporate transactions | 237,051.36 |
| Expense prior to Jan. 1, 1918 | 81,560.91 |
| Total | 1,170,406.67 |
| Balance due from corporation open accounts | 49,297.22 |
| Balance due from corporation | 288,055.15 |
| Other items due to corporation | |
| Material and supplies (shortage) | $247,744.68 |
| Equipment retired | 30,647.50 |
| Road property retired and not replaced | 1,196.33 |
| Interest other than rental interest | 26,520.88 |
| Total | 306,109.39 |
| Other items due from corporation | |
| Additions and betterments | $109,786.74 |
| A&B - Adjustment of prices on M&S used in A&B work | 12,903.10 |
| Total | 122,689.84 |
| Balance due to corporation on other items | 183,419.55 |
| Balance due from corporation | 104,635.60 |
| Depreciation obligation | |
| Equipment | $188,384.00 |
| Balance due to corporation | 83,748.40 |
| Maintenance | |
| Way and structures - Under | $164,999.00 |
| Equipment - Over | 23,747.40 |
| Balance due to corporation on maintenance | 141,251.60 |
| Net balance due to corporation | 225,000.00 |
*3121 *1163 During the period of Federal control two sets of books were kept in the offices of the petitioner, one set being the books of the Director General, or the Federal books, and the other set being the corporate books. Both the Director General and the petitioner had access to both sets of books at all times and after the termination of Federal control the Federal books remained in the offices of the petitioner.
For the ten months of 1920, immediately following the return of the properties of the petitioner, the petitioner expended $334,619.39 for materials and supplies, not including coal, and for the year 1921, the petitioner expended $270,253.63 for materials and supplies, not including coal. Purchase of materials and supplies made by the petitioner after the return of the properties were entered on its books at the prices actually paid and the prices at which the expenditures went into the operating accounts were similarly the prices actually paid. There is nothing to indicate to what extent, if any, the materials and supplies purchased by the petitioner after the return of the properties were replacements of the shortages here in question.
Under date of January 19, 1925, the*3122 Director General made report to the President for the year ended December 31, 1924, together with his final report as to adjustment of claims of carriers whose property was taken over and actually operated by the Government during the 26 months of Federal control. This report includes specifically the petitioner corporation and definitely sets forth "the amount of original claim" and the "amount of final claim of the petitioner," "the tentative set up of the Administration accounts for discussion in final settlement," and the "amount of final settlement," the latter amount being the lump sum settlement of $225,000. In this report the Director General, speaking of the "claims of carriers (including the petitioner) whose property was taken over and actually operated by the Government," said:
It should be understood that final settlements were based on the accounts as prepared and set up made by the Government and not upon the claims presented by the carriers. The final adjustments were made in "lump sums," in accordance with the Railroad Administration's theory of liability, adjusted to meet such meritorious modifications as resulted from the final hearing.
In no instance was*3123 the carrier advised as to the specific allowances made upon particular items claimed, except in the case of non-contract roads, where it was necessary under the law to certify to the Interstate Commerce Commission the amount of compensation finally agreed upon.
There are in the records of the Railroad Administration the details of the investigations made by the administration in setting up its accounts, a record of the office and field examination made of the carrier's accounts, and a full statement showing in detail the items and allowances which finally made up the lump sum paid or collected. Each of these adjustments bear the written and unanimous approval of the director general and the members of his staff.
*1164 OPINION.
MURDOCK: The petitioner has failed to prove that within the meaning of the Revenue Act of 1918 it sustained in 1920 and properly accrued on its books a loss of $10,614.12, the result of a railway accident in which a man was killed. The petitioner appealed from the decision of the Insurance Commission and thus contested the claim that it was liable. We can not determine from the few facts stipulated that there was such a certain and definite*3124 liability on the part of the petitioner in 1920 to pay the amount of the award as to justify the accrual in that year. The stipulation that the amount of the award was accrued in the taxable year and the decision affirmed in the following year does not in the absence of other explanatory facts entitle the petitioner to judgment. . See also .
The Commissioner has held that the petitioner realized taxable income in the amount of $121,750.45 because certain materials and supplies which cost it $113,091.13 were converted into $234,841.58 in cash or a cash credit. He states the issue correctly as follows:
Did the taxpayer realize income in the sum of $121,750.45 in either the year 1921 or the year 1920 on account of the payment to it by the Director General for materials and supplies taken over but not returned, such payment being in excess of the cost of the unreturned materials and supplies by the said amount of $121,750.45?
The petitioner argues that an analysis of the legislative, executive and administrative acts of the United States Government*3125 in connection with Federal control of railroads shows that the Government intended to compensate the railroads for the possession, control, operation and utilization of their properties and, after the period of Federal control, to return the properties to the owners in substantially as good repair and in substantially as complete equipment as they were in when taken over by the Government; this was a distinction between capital and income and the same distinction should be made for income-tax purposes; and whatever cash was paid by the Government to the petitioner to make up a shortage in inventory of materials and supplies merely made capital whole and did not give rise to income.
The acts relating to Federal control should be read with the revenue acts in order to determine the intent of Congress, but we do not believe that Congress ever indicated in any act relating to Federal control of the railroads that circumstances such as are present in this case could not give rise to income. Particularly is this so when we consider the Commissioner's regulations and certain provisions of the Revenue Act of 1921. Under the revenue acts, if a *1165 person parts with his property*3126 and, as a result, receives cash or its equivalent in excess of the cost or, in a proper case, the March 1, 1913, value of the property, he has received income. This is so whether he parted with the property voluntarily or involuntarily.
Under the Revenue Act of 1918, the Commissioner of Internal Revenue by Regulations 24, articles 49 and 50, provided a way whereby one whose property had been converted into cash, under circumstances similar to those in the present case, could relieve himself from tax liability on the income resulting from the conversion. The Revenue Act of 1921, in sections 202(d)(2) and 234(a)(14), recognized and incorporated such a method of relief in the law and in the latter provided, in part, that:
* * * If the taxpayer proceeds forthwith in good faith, under regulations prescribed by the Commissioner with the approval of the Secretary, to expend the proceeds of such conversion in the acquisition of other property of a character similar or related in service or use to the property so converted * * * then there shall be allowed as a deduction such portion of the gain derived as the portion of the proceeds so expended bears to the entire proceeds. * * *
*3127 Pursuant to the above statute, the Commissioner promulgated Regulations 62, containing, inter alia, articles 49, 261, 262 and 263. Article 49 provided that the gain should be included in gross income, but if the taxpayer proceeded forthwith in good faith to replace the property as provided in section 214(a)(12), then articles 261 to 263, inclusive, should be followed. Article 261 required that the newly restored property should not be valued in the accounts of the taxpayer at an amount in excess of the cost or March 1, 1913, value of the old property. This feature of the Commissioner's regulations, which was the same both before and after the passage of the Revenue Act of 1921, seems to us to be a reasonable provision and the sort of a provision that Congress expected would be made. Otherwise, during a period of rising prices, the conversion would not only result in no harm to the owner of the property from an income tax standpoint, but would improve his position for income-tax purpose in that the restored property would go through his accounts at a higher cost than the cost or March 1, 1913, value of the property which was converted. In view of the method thus provided, *3128 whereby the petitioner could have been relieved of all tax in regard to the income now in controversy without at the same time laying a basis for a double deduction by a reduction of its future income, we can not read any inhibition in the acts relating to Federal control which would preclude the possibility of income to the petitioner from the transaction set forth in the findings of fact in this case. , is clearly distinguishable.
The question with which we are concerned is whether or not the petitioner had income which it should have reported. The question *1166 of a deduction from income has not been raised. But even if such a question were in issue the evidence shows that the petitioner has not complied with the regulations of the Commissioner and is not entitled to deduct any amount because of the expenditure of the proceeds of the conversion in the acquisition of other property of a character similar or related in service or use to the property so converted. In the first place, its claim that it has replaced the property converted is not very clearly supported by the evidence. If a railroad*3129 annually purchases a certain amount of materials and supplies and, on a certain date, has a quantity of materials and supplies on hand, which quantity then on hand is taken from it, has it shown that it has replaced the quantity on hand by showing that in subsequent years it purchased the usual quantity of materials and supplies, or only slightly in excess of the usual quantity, the amount of which excess is not shown? Regardless of the adequacy of the petitioner's proof on this point, the evidence clearly shows that the regulation of the Commissioner in regard to the amount at which the restored property should be entered in the accounts has been totally ignored. But these matters would be material only in case the question of a deduction were before us and, as we have said, such a question is not before us.
The petitioner further argues that the "lump sum settlement" between it and the Director General can not be separated or broken down into component parts because the parties never reached any agreement as to the various items involved, and consequently a profit on the conversion of the materials and supplies can not be charged to the petitioner. It is true that the petitioner*3130 did not know the various amounts used by the Director General in his computation as a result of which his final offer was made. But despite this fact the petitioner was not in complete darkness, at the time of the final settlement, in regard to what the Director General was willing to allow on the various claims and particularly on the claim for shortage in materials and supplies and in regard to what he did allow. During the period of Federal control the Director General had maintained a set of books in connection with the operation of the petitioner's railroad. These books showed as of the end of 1920 the various amounts in various accounts due either from the Director General to the railroad or from the railroad to the Director General. So far as we have been able to determine the Director General Never maintained that any greater amount was due him from the petitioner or that any lesser amount was due the petitioner from him than the amount shown by these books. The petitioner was aware of this fact and in 1920 actually entered on its books as accruals some of the amounts shown on the Federal Books. In the final settlement *1167 the only controversy between the parties*3131 and the only uncertainty which the petitioner might reasonably have had as to materials and supplies was as to any additional amount claimed and allowed on account of the shortage in materials and supplies over and above $234,841.58, the amount which the Federal books showed was due from the Director General to the petitioner on account of this shortage. In his computation of the net balance of $225,000 due to the corporation which the Director General finally allowed as a lump sum settlement it appears that he increased his allowance on account of the shortage in materials and supplies over the figure shown by the Federal books to $247,744.68, and then exactly offset the increase by entering a new item due to him from the petitioner. The petitioner did not know that the increase had been allowed and then offset. But in his computation of the income derived by the petitioner from the conversion, the Commissioner has disregarded the increase which the Director General made and is only contending that the petitioner received the lesser amount, $234,841.58, on account of the shortage of materials and supplies, and we believe that the petitioner knowingly received at least this amount*3132 of money on account of the shortage in materials and supplies.
The Commissioner computed the gain from the cash credit for the shortage in materials and supplies in this way: From $336,700.71, the cost of the inventory of materials and supplies taken over by the Director General as of January 1, 1918, he subtracted $223,609.58, the cost of the inventory of materials and supplies turned back to the petitioner on March 1, 1920, and used the remainder as the cost of the materials and supplies which were not returned. The petitioner has contented itself with an argument that it would be more just and equitable to apportion the total cost of $336,700.71 or the total profit of $121,750.45 between the items for which cash compensation was given and the items returned in kind, in the proportion as $234,841.58, the cash returned to the petitioner, is to $223,609.58, the cost of the inventory returned to the petitioner. No good reason occurs to us why this particular method for estimating the cost should be adopted. If we knew the real cost of the property which was not returned we could accurately determine the income which the petitioner received from the cash credit. So far as we know, *3133 the actual cost could have been proven, but no effort was made to prove it.
We have not been told enough about the articles physically returned or replaced on March 1, 1920, to know whether or not or to what extent their cost was the same as the cost of the same or similar articles in the inventory turned over on January 1, 1918. The Commissioner subtracted the total cost shown by the March *1168 1, 1920, inventory from the total cost shown by the inventory of January 1, 1918, as if a dollar in one were the equivalent of a dollar in the other. If the Director General had purchased any article which he returned, since prices were generally rising, he might have bought it at a greater cost than the cost of a similar article in the inventory of January 1, 1918, and to this extent the Commissioner's subtraction on a dollar-for-dollar basis would have been erroneous. But we do not know whether or not be purchased any articles or the cost of any articles which he purchased or to what extent the articles which he turned back were the same articles which he had taken over. The petitioner in its brief states:
It is even possible, and highly probable in an inventory of this size*3134 that the inventory turned back contained many of the very units which were taken over.
The petitioner therefore has not shown that the Commissioner's computation of income in the amount of $121,750.45 was in error.
Counsel for the respondent at the hearing contended that if the Board should not find that the income from this transaction was income for 1921, then it was income for 1920, on the theory that the amount of $234,841.58 finally allowed the petitioner in the lump sum settlement should have been accrued for 1920, when the properties were turned back. The respondent points out that the contract of March 26, 1919, in section 9(b), made specific provision for the payment for any shortage in materials and supplies at the time the property was returned at prices prevailing at the end of Federal control; the shortage was known in 1920, and the prices were known; and a mathematical computation would have determined the amount due from the Director General, which computation was actually made on the books of the Director General as of December 31, 1920. Conceding the correctness of all of these facts, nevertheless the parties were in substantial disagreement in regard to this*3135 item and the respondent has failed to show that in 1920 the petitioner knew that it would get at least $234,841.58 on account of the shortage, and we can not say as a matter of law under all of the facts in this case that this amount should have been accrued at that time.
Reviewed by the Board.
Judgment will be entered under Rule 50.
PHILLIPS, GREEN, MILLIKEN, and VAN FOSSAN dissent.
Footnotes
1. Reduction. ↩