1927 BTA LEXIS 2560">*2560 Where petitioner, on accrual basis, with fiscal year ending September 30, tendered goods, during and immediately prior to September, 1920, under a contract for the sale thereof by sample, subject to inspection and rejection within a specified time if not conforming to sample and contract, the sale price having been accrued on its books, and on September 25, 1920, the goods were rejected by the buyer, held, that the petitioner should not include the sale price of the goods in gross income for the year ended September 30, 1920.
9 B.T.A. 579">*579 This proceeding is for the redetermination of a deficiency in income and profits tax for the fiscal year ended September 30, 1920, in the amount of $66,729.95. The entire amount of the deficiency is not in dispute but only so much thereof as arises from the respondent's action in including in petitioner's taxable income for the fiscal year ended September 30, 1920, the amount of $55,992.38, the price of certain flannel goods shipped under a sales agreement, during1927 BTA LEXIS 2560">*2561 the fiscal year, and which goods, it is alleged, were rejected and charged back to the petitioner under the circumstances set out below.
FINDINGS OF FACT.
The petitioner is a North Carolina corporation, with its principal office at Forest City, N.C. Its business is that of manufacturing cotton goods.
Catlin & Co., of New York City, were the sole agents for the sale of the goods manufactured by the petitioner. Under date of January 9 B.T.A. 579">*580 13, 1920, Catlin & Co., as agents of the petitioner, entered into a contract with B. Freeman & Co. for the sale on sample of 100 cases of goods known as "Florence flannels," manufactured, or to be manufactured, by the petitioner, the contract price being $58,023.19. The sales contract of January 13, 1920, contained among others, the following stipulation:
If buyer fails to reject goods for any cause within thirty days from date of their arrival at point of consignment, such goods shall be deemed to be accepted as good delivery under the terms of this sales note.
Pursuant to the sales agreement, during and immediately prior to September, 1920, the petitioner shipped to, and B. Freeman & Co. received, 100 cases of goods purporting1927 BTA LEXIS 2560">*2562 to be the goods designated in the agreement, and accrued the contract price in its gross sales for the year ended September 30, 1920, in the amount of $58,023.19. Such accrual was in accordance with petitioner's established practice of bookkeeping.
By letter dated September 25, 1920, addressed to Catlin & Co., B. Freeman & Co. stated with respect to the 100 cases of goods, in part, as follows:
We have examined to date, a total of 179 pieces, containing a total of approximately 10,000 yards. These goods, as we have stated to you in our previous communications, are from your recent shipments and recent arrivals, the case numbers being 3601, which arrived at our premises on the 11th day of September, 3561 which arrived the same date, 3676 which arrived on the 15th day of September, 3512 and 3548 which arrived on the 7th of September.
We have found throughout these 179 pieces of merchandise, that not only is it nothing like the sample which you delivered to us, but it is full of various defects, running thick and thin bars, and unusual number of broken threads, contain slugs and slug holes in unusual proportion, some pieces are even so stained and damaged, that we could not possibly1927 BTA LEXIS 2560">*2563 market same, under any circumstances. We have found certain of the pieces cut in two parts. These defects are not confined to one or a dozen pieces here or there. In order to be absolutely fair to you, we took the precaution to have each of these 179 pieces separately examined by a competent examiner, and his complete report is before us.
* * *
We do not propose to have loaded on our hands under this contract, a lot of rotten unmarketable stuff which you are suddenly shipping to us, because you cannot find market for them elsewhere. We are perfectly willing to go over each piece of merchandise in this contract. Whatever we agree upon that is in accordance with sample, we will be more than glad to accept under our contract. Under no circumstances, however, will we accept any of the foregoing cases, that we have made reference to of the 179 pieces, nor will we accept any other portion of this contract, which runs like these 179 pieces. We are having the balance examined.
Now if this is agreeable to you, in all fairness to go over with us, all of the cases which are as yet unopened, and decide which of the merchandise is in 9 B.T.A. 579">*581 accordance with the sample, we will1927 BTA LEXIS 2560">*2564 be more than glad to do so, and in this way, avoid making a total rejection of the entire shipment. Unless you are, however, agreeable to doing this, we desire you to have notice now that the entire shipment is rejected and that you are requested to call and take back all of the cases forwarded to us, under this contract for 100 cases.
We have seen enough of this merchandise to be satisfied that the largest part of the shipment is not any better. We are continuing with our examination. Unless you are agreeable to getting together on the lines outlined above, in an effort to sift the good from the bad, there is only one position open to us, and that is that we must ask you to immediately call for the return of all of the hundred cases of merchandise.
Kindly advise us promptly as to what is your intention in this matter, and oblige,
Yours very truly,
B. FREEMAN & CO.No action was taken by Catlin & Co., with respect to the proposition made by B. Freeman & Co. that a joint examination of the goods be made. It was not until December 17, 1920, that the petitioner was advised by Catlin & Co., that B. Freeman & Co. had complained of the 100 cases of goods. The petitioner1927 BTA LEXIS 2560">*2565 was then advised by Catlin & Co., in part, as follows:
I am very glad to know that you have been able to postpone the Internal Revenue tax returns until Jan. 15th, and also that you have been able to get an abatement on account of returns and allowances. This is very fortunate, as there are three very important matters which have been pending, which I think now should be put into the mill accounts, and Catlin & Co., will send you full details in another letter.
We have been having a long fight with our customer on Order #2493, who has declined to pay for 100 cases, on the ground that the quality was not up to standard, and we have finally placed the matter in the hands of our lawyers. We have not written you about this, hoping to get some basis of settlement from him, but it seems to us that this is the time now to charge that whole amount back, so as to get it into your tax returns. He refuses to pay his bills, refuses to accept the goods as a good delivery, and at present there seems to be no hope of settlement except through the courts, and that may be a matter of two or three years.
* * *
This completes all of the matters in controversy, but this certainly is very1927 BTA LEXIS 2560">*2566 bad indeed, and we feel that the only thing is to charge them back to the account now and save your taxes and we will recover what we can later. We will put them into the account as stock, but not release the buyer, and then they will have to be readjusted on the new market price undoubtedly, if we cannot do better.
Shortly after Catlin & Co.'s letter of December 17, 1920, there was sent to the petitioner a statement of account by reason of which part of the goods to the amount of $55,992.38, covered by the sales agreement of January 13, 1920, with B. Freeman & Co., were charged back to the petitioner, who thereupon deducted the amount from gross sales for the year ended September 30, 1920.
9 B.T.A. 579">*582 On or about April 15, 1921, the petitioner brought suit against B. Freeman & Co. to recover the sum of $57,446.32. Thereafter, during the pendency of the suit, it was agreed by counsel for the parties that the goods, which were still in the possession of B. Freeman & Co., might be sold and the proceeds paid to the petitioner, and be credited against the amount of any judgment that might be obtained against B. Freeman & Co. Pursuant to this agreement, the goods were thereafter1927 BTA LEXIS 2560">*2567 sold by Catlin & Co., for the account of the petitioner.
Subsequently, B. Freeman & Co. paid the petitioner $20,000 in settlement of all claims arising out of the suit filed on or about April 15, 1921, whereupon the suit was dismissed, the cause not having come to trial.
In its return for the fiscal year ended September 30, 1920, the petitioner included the goods, which were charged back, in its inventory at cost or market value, whichever was lower.
The petitioner kept its books of account on the accrual basis and upon audit of its return for the fiscal year ended September 30, 1920, the Commissioner determined that the goods charged back by the petitioner, and carried in its inventory, should be included in taxable income for that period.
OPINION.
LOVE: The sole question in this proceeding is whether the amount of $55,992.38, the contract price of the goods which the petitioner alleges were rejected within the fiscal year ended September 30, 1920, should be included in the petitioner's gross income for that year.
It should be noted at the outset that the total contract price of the goods was $58,023.19, while the goods charged back amounted to $55,992.38. In view1927 BTA LEXIS 2560">*2568 of the fact, however, that it is alleged by the petitioner that the amount of $55,992.38 was erroneously included in its taxable income for the year in question and that the respondent in his answer denied he committed error in so doing, we presume that with respect to the difference of $2,030.81, there is no dispute as to those goods or as to the treatment of their selling price. We will confine our inquiry, therefore, to the question as to whether the goods charged back by the petitioner should or should not be included in its closing inventory for the fiscal year 1920.
After entering into the contract for the sale of the goods in question and sometime during the fiscal year 1920, the petitioner in pursuance of its bookkeeping methods, accrued on its books the contract price thereof. However, the petitioner in making its return for the year in question deducted from gross sales the amount of the goods 9 B.T.A. 579">*583 which it alleges were rejected, and returned those goods to inventory. In support of its action in this respect, the petitioner takes the position that where a contract has been entered into for the sale of goods on sample during the taxable year and the goods shipped1927 BTA LEXIS 2560">*2569 to apply on the contract have been rejected by the vendee and thrown back on the hands of vendor before the close of the taxable year, the vendor, being on the accrual basis, should deduct from gross sales the price of any goods returned. The respondent agrees with this contention but he urges that the goods in question were not rejected and that the petitioner did not consider them as rejected.
Whether the petitioner considered the goods as rejected is not, in our opinion, controlling. The sales agreement clearly indicates that the parties thereto contemplated that the goods might be rejected. Therefore, if, as a matter of fact, the goods in question were rejected prior to the close of the fiscal year, it is clear that they should be included in petitioner's inventory for the reason that petitioner had only a cause of action against the buyer, the outcome of which was, of course, uncertain and, consequently, not accruable.
By the terms of the sales agreement the buyer had thirty days within which to reject the goods. On September 25, 1920, B. Freeman & Co. wrote to petitioner's agent, complaining about the quality of the goods and stated:
Unless you are agreeable to getting1927 BTA LEXIS 2560">*2570 together on the lines outlined above, in an effort to sift the good from the bad, there is only one position open for us, and that is we must ask you to immediately call for the return of all of the hundred cases of merchandise.
It will also be observed that on December 17, 1920, petitioner was advised by its agent that B. Freeman & Co. declined to accept the goods as good delivery or to pay for them.
Considering the letter of September 25, 1920, in the light of subsequent events, we are of the opinion that by that letter B. Freeman & Co. intended to exercise and did exercise the option to reject the goods in question as provided for in the sales agreement.
The goods in question having been rejected prior to the close of the fiscal year, we conclude that the respondent erred in determining that the amount of $55,992.38 should be included in petitioner's income for the fiscal year ended September 30, 1920.
Judgment will be entered on 15 days' notice, under Rule 50.
Considered by TRUSSELL, SMITH, and LITTLETON.