1929 BTA LEXIS 2515">*2515 Where a taxpayer at the time of taking the closing inventory for one year and the opening inventory for another had on hand certain articles, some of which were manufactured by it at a certain cost and some of which were purchased by it at a higher cost, but due to the intermingling of the articles it can not tell what part of the articles were manufactured by it and what part purchased, the Commissioner's determination of a deficiency for the latter year in which the articles were inventoried at the taxpayer's manufacturing cost will not be disturbed where in addition it appears that in its closing inventory for the preceding year the taxpayer used and the Commissioner approved the inventory on this same basis.
16 B.T.A. 788">*788 This is a proceeding for the redetermining of a deficiency in income and profits taxes asserted by the respondent for 1919 in the amount of $41,510.68. Six assignments of error were made in the petition, of which two were withdrawn by the petitioner at the hearing, leaving for consideration the following: (1) 1929 BTA LEXIS 2515">*2516 The Commissioner failed to allow as a deduction the sum of $7,360.40, being the amount paid to the United States in respect to final settlement of claims under war contracts; (2) failed to correct an understatement of $130,104.30 in the inventory of December 31, 1918, which resulted in a corresponding overstatement of the net income for 1919; (3) failed to correct understatement of earned surplus for invested capital purposes, due to understatement of inventory of December 31, 1918; (4) deducted a tentative tax in determining the amount of earnings available for distribution, for invested capital purposes. At the hearing, the respondent conceded that the sum of $7,360.40 paid to the United States, being the amount referred to in the first assignment of error, should be excluded from gross income.
FINDINGS OF FACT.
The petitioner, a Pennsylvania corporation with its principal office at Bridgeville, Pa., was formerly known as the Universal Rolling Mills Co. During 1918 it was engaged in the manufacture of high quality tool steel plates and sheets for commercial use, and in the manufacture of armor plate under Government contracts.
16 B.T.A. 788">*789 The armor plate manufactured by1929 BTA LEXIS 2515">*2517 the petitioner under Government contracts is divisible into three classes, namely: (1) plate produced entirely in the petitioner's plant; (2) plate rolled from ingots purchased from the Union Electric Steel Co. of Carnegie; and (3) plate finished rolled only from slabs which had been rolled by the Carbon Steel Co. out of ingots sold to the petitioner, and delivered to the Carbon Steel Co. by the Union Electric Steel Co.
The costs of manufacturing the various armor plate materials, according to the classes described above, were as follows:
| Materials | Cost per Pound |
| Diebold #1, 10 ton tractor size: | |
| Cogged material - | |
| Class 1 | $0.14806 |
| Class 2 | .16567 |
| Raw plates not sheared - | |
| Class 1 | .17357 |
| Class 2 | .19672 |
| Class 3 | .14141 |
| Rough sheared plate - | |
| Class 1 | .22585 |
| Class 2 | .25064 |
| Class 3 | .17413 |
| Diebold #2, 5 ton tractor size: | |
| Cogged material - | |
| Class 1 | .14806 |
| Class 2 | .16567 |
| Raw plates not sheared - | |
| Class 1 | .17357 |
| Class 2 | .19672 |
| Class 3 | .14141 |
| Rough sheared plate - | |
| Class 1 | .22585 |
| Class 2 | .25064 |
| Class 3 | .17413 |
| 2 1/2 ton tractor size: | |
| Cogged material - | |
| Class 1 | .14806 |
| Class 2 | .16567 |
| Rough sheared plate - | |
| Class 1 | .22585 |
| Class 2 | .25064 |
| Class 3 | .17413 |
1929 BTA LEXIS 2515">*2518 The petitioner also purchased rough sheared plates from the Hussey-Binns Steel Co. for fabrication into finished armor plate by its subcontractors. The total of such purchases amounted to 2,734,700 pounds, at a cost of $1,016,639.38, which is an average cost of 37.17 cents per pound.
The total quantity of rough sheared plates shipped by the petitioner to its subcontractors, for fabrication into finished armor 16 B.T.A. 788">*790 plate, amounted to 5,373,877 pounds, of which 2,956,739 pounds were manufactured in the petitioner's mills, and the remainder, 2,417,138 pounds, had been purchased from the Hussey-Binns Steel Co. Of the 2,956,739 pounds of rough sheared plates manufactured in the petitioner's mills and shipped to subcontractors, 261,506 pounds were finished, rolled only from slabs which had been rolled by the Carbon Steel Co. out of ingots sold to the petitioner by the Union Electric Steel Co.
In its return for 1918 the petitioner reported a closing inventory of $942,398.03, purported to have been take upon the basis of cost or market, whichever was lower, and, in the return for 1919, reported the same as its opening inventory of that year. This inventory included, among1929 BTA LEXIS 2515">*2519 others, the following items of armor plate materials:
| Items | Quantity | Unit price | Value | |
| Diebold #1, 10 ton rough sheared plate: | ||||
| Purchased | pounds | 55,303 | $0.3717 | $20,556.12 |
| Own manufacture and purchased mixed | do | 657,573 | .2358 | 155,055.71 |
| Diebold #2, 5 ton rough sheared plate: | ||||
| Purchased | do | 261,559 | .3717 | 97,221.48 |
| Own manufacture and purchased mixed | do | 899,892 | .2358 | 212,194.53 |
| Operating account, Government materials: | ||||
| Ingots | tons | 366.8 | 142.13 | 52,133.28 |
| Cogged, semifinished | do | 255.943 | 300.49 | 67,893.65 |
| Sheared, finished | do | 21.754 | 471.59 | 10,258.97 |
| Duncan & Miller, rough sheared plate: | ||||
| Own manufacture | pounds | 1,518 | .2358 | 357.94 |
The quantities included under "10 ton rough sheared plate" and "5 ton rough sheared plate," as "purchased" materials, to wit: 55,303 pounds and 261,559 pounds, respectively, were stored in the warehouse at Bridgeville, and were specifically identified as having been purchased from the Hussey-Binns Steel Co. The remaining quantities of those materials were at the plants of subcontractors, where they had been so intermingled that it was not possible to identify which had been manufactured in1929 BTA LEXIS 2515">*2520 the petitioner's mills and which, if any, had been purchased from the Hussey-Binns Steel Co.
The unit price of 23.58 cents per pound assigned to the materials included under "10 ton rough sheared plate" and "5 ton rough sheared plate," as "own manufacture and purchase mixed," to wit: 657,573 pounds and 899,892 pounds, respectively, was the average cost of manufacturing rough sheared plate of the three classes heretofore described in the petitioner's own mills.
The Government reserved the right to terminate its contracts with the petitioner in the event of cessation of hostilities. In the event of the termination of the contracts, the petitioner was to be compensated for the cost of all work done and materials purchased and costs incurred. The only market at December 31, 1918, which existed for the armor plate materials in the inventory was as provided by the termination clauses of these contracts.
16 B.T.A. 788">*791 The 5 and 10 ton rough sheared plates on hand at December 31, 1918, were disposed of to the Government by a settlement agreement in complaince with the terms of the contracts under which these materials had been prepared. Settlement for these materials, as well as1929 BTA LEXIS 2515">*2521 for those on hand but unfinished at the cessation of hostilities and determination of the contracts, was made by the Government upon the basis of the costs heretofore set out in these findings, said costs having been audited and approved by the Ordnance Bureau of the War Department.
In determining the amount of earnings available for distribution for invested capital purposes, the Commissioner deducted a tentative income and profits tax. As a result of this action he reduced invested capital by $61,474.91.
OPINION.
MURDOCK: The first assignment of error is that the Commissioner failed to allow the deduction of $7,360.40, the amount paid to the United States in respect of final settlement of claims under war contracts. This has been disposed of by the admission of the respondent's counsel at the hearing, that the amount in question should be excluded from gross income rather than deducted as an item of expense. The net income shown in the deficiency notice should be reduced therefore, by the sum of $7,360.40.
The second assignment of error is that the Commissioner failed to correct an understatement of $130,104.30 in the inventory of December 31, 1918, which is the opening1929 BTA LEXIS 2515">*2522 inventory for 1919, and that failure to correct the inventory has resulted in an overstatement of net income of a corresponding amount for 1919. In its return for 1918, the petitioner computed the cost of goods sold by using a closing inventory valued at $942,398.03. It computed the cost of goods sold in the return for 1919 by using an opening inventory of the same amount. If the petitioner is correct in its contention that the inventory has been understated by $130,104.30, then the net incomes of 1918 and 1919 have been understated and overstated, respectively, by like amounts.
The petitioner asserts that the error in the inventory is due to the pricing of 657,573 pounds of 10 ton rough sheared plate and 899,892 pounds of 5 ton rough sheared plate on hand at the plants of subcontractors at December 31, 1918, at the average cost to manufacture such materials in its own plant, to wit: 23.58 cents per pound. It contends that a large portion of these materials was purchased from the Hussey-Binns Steel Co. at an actual cost of 37.17 cents per pound. All of the rough sheared plate manufactured in the petitioner's mills and purchased from the Hussey-Binns Steel Co. was shipped to1929 BTA LEXIS 2515">*2523 subcontractors' mills for fabrication into finished armor 16 B.T.A. 788">*792 plate. At the subcontractors' mills these manufactured and purchased materials were intermingled indiscriminately. The petitioner asks that we determine what portions of these materials were manufactured in its own mills by taking the same proportion of each as the total quantity of rough sheared plate manufactured in its mills, to wit: 2,956,739 pounds, bears to the total quantity of rough sheared plate shipped to subcontractors, to wit: 5,373,877 pounds, and that the balance of the materials in the inventory be regarded as having been purchased at a cost of 37.17 cents per pound. On this basis the petitioner contends for, and asks us to find, an average cost for the 10 ton and 5 ton rough sheared plate manufactured and purchased of 30.81 cents per pound and 33.7 cents per pound, respectively.
We can not say upon the evidence before us that the inventory of December 31, 1918, as twice returned by the petitioner and apparently as often accepted by the respondent, is clearly incorrect. It is only by indulging, as the petitioner asks us to do, in the probabilities of the matter that there appears to be any force1929 BTA LEXIS 2515">*2524 whatever in the petitioner's contentions. But whatever the probabilities may seem to be, they are outweighed by other considerations of greater importance. The respondent has determined that the inventory as twice returned by the petitioner was correctly valued, both as to manufactured and purchased materials, and the prima facie correctness of that determination can only be overcome by satisfactory proof of error, and not by mere indulgence in the mathematical probabilities of the situation. In , we were confronted with a somewhat similar situation, and we refused to disturb the respondent's determination as to the value of the inventory of the preceding year, holding that "Determinations of the Commissioner involving inventories which have compensating effects upon succeeding taxable years are not to be disturbed except by clear and convincing evidence of error, particularly in cases in which the taxpayer has received the benefit of alleged error in an earlier year barred at the time of appeal to this Board by the statute of limitations."
We do not have the year 1918 before us, and if we did have, it is doubtful that the petitioner1929 BTA LEXIS 2515">*2525 would have raised this issue, since, if it is correct in its contention, the net income of that year has been understated by the amount of the alleged error in the inventory. Thus, holding to the advantage which it has already secured in 1918, the petitioner seeks to gain a like advantage for the second time in computing the net income for 1919. But in this it can not prevail without more convincing evidence of error than that now in the record. The respondent's determination as to the value of the inventory at December 31, 1918, and its resulting effect upon net income and invested capital will not be disturbed.
16 B.T.A. 788">*793 In determining the amount of current earnings available for distribution, the Commissioner has deducted a tentative income and profits tax. The deduction of such a tax has resulted in a reduction of $61,474.91 in invested capital. The Commissioner's action is contrary to the decision of this Board in . The invested capital shown by the deficiency notice should be increased by the amount of $61,474.91.
Judgment will be entered under Rule 50.