Decisions will be entered under Rule 50.
1. During the tax years in which the issue is presently in controversy, petitioners, which used inventories priced at cost or market whichever is lower, valued their steel in accordance with the posted prices of the major steel-producing mills. However, by reason of governmental controls and shortages occasioned by the Korean conflict, petitioners were not able to purchase steel from the major mills. Instead, steel was obtained primarily from one of a number of smaller mills at premium prices (considerably higher than the prices of the major mills), and, under OPS regulations, such steel could in turn be resold at a 50 per cent markup. Held, the Commissioner properly disapproved the use of the major mill prices in pricing petitioners' inventories; petitioners' "market" was the one in which they actually purchased their steel and not the theoretical market of the major mills that was not open to them.
2. Held, except for inventory dates of December 31, 1953, and August 31, 1954, the Commissioner's adjustment of inventory values for second quality and scrap steel approved. As to inventories on December 31, 1953, and August 31, 1954, held, *101 values determined by petitioners were too low, but proper values should be not less than prevailing major mill prices for first quality steel, since that market was open to petitioners at those times rather than to petitioners' higher cost in a different market.
3. Held: "Freight-in" is not deductible as a current expense; it must be treated as part of cost of acquiring merchandise. Amount of "freight-in" determined.
4. Held, there was in fact no obligation to pay interest by one petitioner to the other on an open account during the fiscal year ended August 31, 1954; accordingly, a deduction for interest claimed by the debtor for that year was properly disallowed.
5. Held, the contribution of one of the petitioners towards the paving of a dead end street adjoining its warehouse was a capital item for which it is entitled to depreciation.
*777 Respondent determined deficiencies in petitioners' income taxes as follows:
| Docket No. | Year ended | Deficiency |
| Aug. 31, 1952 | $ 1,574.87 | |
| 71711 | Aug. 31, 1953 | 23,488.21 |
| Aug. 31, 1954 | 1,685.92 | |
| Dec. 31, 1951 | $ 131,583.06 | |
| 71712 | Dec. 31, 1952 | 25,558.25 |
| Dec. 31, 1953 | None |
In *102 Docket No. 71711, the deficiency for the fiscal year ended August 31, 1952, resulted from respondent's disallowance of a net operating loss carryback from the fiscal year ended August 31, 1954. In Docket No. 71712, respondent did not determine a deficiency for the taxable year ended December 31, 1953, but he did make certain inventory adjustments for that year which affected the amount of a net operating loss carried back to the taxable year ended December 31, 1952.
The questions presented are:
(1) Did petitioner D. Loveman & Son, Inc., improperly determine the market value of its inventories of first quality steel as of December 31, 1951, and December 31, 1952? Did petitioner D. Loveman & Son Export Corporation improperly determine the market value of its inventory of first quality steel as of August 31, 1953?
(2) Did petitioner D. Loveman & Son, Inc., improperly determine the market value of its inventories of alleged second quality and scrap steel as of December 31, 1952, and December 31, 1953? Did petitioner D. Loveman & Son Export Corporation improperly determine the market value of its inventory of alleged second quality and scrap steel as of August 31, 1953?
(3) Is petitioner *103 D. Loveman & Son, Inc., entitled to treat as a current expense, rather than as a part of cost of goods, the amount of its "freight-in" for 1951, 1952, 1953? If not, what is the amount of "freight-in" applicable to its closing inventories in those years?
(4) Is petitioner D. Loveman & Son Export Corporation entitled to deduct interest accrued by it with respect to an indebtedness to D. Loveman & Son, Inc.?
(5) Is petitioner D. Loveman & Son Export Corporation entitled to deduct its share of paving a road adjacent to its warehouse or, in the alternative, is it entitled to deduct any amount representing depreciation thereon?
*778 FINDINGS OF FACT.
Petitioners D. Loveman & Son, Inc. (hereinafter referred to as Domestic), and D. Loveman & Son Export Corporation (hereinafter referred to as Export) are Ohio corporations, each having its principal office in Bedford Heights, Ohio, and each employing an accrual method of accounting.
Domestic reports its income on a calendar year basis whereas Export uses a fiscal year ending August 31. Domestic filed its corporate income and excess profits tax return for 1951, and an amended return for 1951 dated July 16, 1952, with the collector of internal revenue *104 for the eighteenth district of Ohio; it filed its returns for 1952 and 1953 with the district director of internal revenue at Cleveland, Ohio.
Export filed its income and excess profits tax return for the fiscal year ended August 31, 1952, with the collector of internal revenue for the eighteenth district of Ohio; it filed its returns for the fiscal years ended August 31, 1953, and August 31, 1954, with the district director of internal revenue at Cleveland, Ohio.
Both Domestic and Export are engaged in the business of buying and selling steel materials and, since incorporation, each has used the lower of cost or market method in pricing its inventories. Domestic was incorporated on January 2, 1946, as the successor to a partnership formed in 1931 by David Loveman and his son, Darwin E. Loveman (hereinafter referred to as Loveman). Export was incorporated on September 8, 1947, as the result of the development of steel sales to foreign countries. During the taxable years in question, Loveman and Herbert Merlin (hereinafter referred to as Merlin) served as vice president and secretary-treasurer, respectively, of both corporations. Merlin entered the steel business in 1946 when he joined *105 Domestic.
Prior to 1951, and during the existence of its predecessor partnership, Domestic did not require and did not have a warehouse of its own, preferring whenever possible to arrange for the direct shipment of steel from producing mill to customer. Occasionally, it would store merchandise in a public warehouse. At December 31, 1950, Domestic's entire inventory consisted of two lots of steel, as follows:
| Shipment in transit on high seas, priced at cost f.o.b. Rotterdam | $ 45,846.76 |
| Merchandise at Weiss Steel Company, Forest Park, Illinois, priced | |
| at cost | 6,515.60 |
| Total | 52,362.36 |
On November 29, 1951, the Office of Price Stabilization promulgated Ceiling Price Regulation 98 (hereinafter referred to as C.P.R. 98) for the stated purpose of correcting the "chaotic" situation in *779 the resale market for steel products which had arisen following the outbreak of hostilities in Korea. C.P.R. 98 established resale ceiling prices for steel products on the basis of "uniform industry-wide resale percentage markups * * * over current material costs," with allowances for "customary geographical differentials." At the same time, however, it prohibited resellers of steel from marking up the price of any *106 steel product which was resold without first having been put through a warehousing operation. The term "warehousing of iron or steel products" was defined in C.P.R. 98 as --
the actual receipt and unloading of iron or steel products for sale or resale in substantially the same form as received into premises regularly maintained (not a public warehouse) and equipped with facilities for performing such operations as receiving, stocking, sorting and grading, pipe-threading, cutting, shearing, flame-cutting or burning to size and shape, and shipping and other like operations which are necessary or incidental to the resale and distribution of the particular products brought into those premises.
Domestic was not engaged in a warehousing operation within the purview of C.P.R. 98. Therefore, before the end of 1951, Domestic found it necessary to obtain, and for the first time did obtain, private warehouse facilities in Cleveland. In 1953, Domestic leased space at Export's Perkins Road warehouse in Bedford Heights, Ohio.
The Korean conflict, and the resultant shortage of steel supply in relation to demand, also impaired Domestic's ability to purchase steel from its regular sources of supply. *107 Prior to the fall of 1951, Domestic was able to purchase most of its steel requirements from such major mill producers as Jones & Laughlin Steel Corporation, Republic Steel Corporation, and Bethlehem Steel Corporation. With the development of the steel shortage, however, Bethlehem stopped shipping steel to the Cleveland area, and the other major producing mills refused to sell to Domestic because their production was already spoken for by virtue of allocations and priorities to other customers. Consequently, Domestic was forced to turn for its steel supplies to a so-called "premium mill."
In the fall of 1951, Domestic established contact with Central Iron & Steel Corporation of Harrisburg, Pennsylvania (hereinafter referred to as Central). Central was located in the same geographical area as the major mill producers from whom Domestic had previously purchased. It was a "premium mill" in that in periods of short supply its prices were substantially higher than those of the major producers. Central was able to charge these higher prices because its customers, such as Domestic, were unable to secure steel elsewhere. In times of normal supply and demand, Central's prices would be *108 the same as, or sometimes lower than, the prices of the major producing mills.
From December 1951 through December 1953, most of Domestic's *780 steel purchases were made from Central. Approximately 90 per cent of the steel sold by Domestic consisted of sheared carbon steel plate. Under the ceiling price limitations of C.P.R. 98, Domestic, as a warehouseman in the Cleveland area, was permitted to sell carbon steel plate, regardless of quality, at a percentage markup of 50 per cent over the cost to it of purchasing such plate. To the ceiling price so computed, C.P.R. 98 permitted the addition of incoming freight costs, plus "all published extras for size, quantity, quality, merchandising, finish, tolerance, cutting, coating, boxing, or other extras * * * in effect for the same items on January 25, 1951."
As of December 31, 1951, the demand for steel among Domestic's customers was sufficiently great to absorb all of its "first quality" (or "prime") steel at the full permissible markup over Central's premium price. C.P.R. 98 was withdrawn on March 17, 1953, following a falling off in the demand for steel which began in the closing months of 1952. This decline in demand was first felt by *109 warehousemen; it was not felt by the mills until 6 months to a year later because of order backlogs. Domestic was not able to purchase any steel from major mills until September or October 1953, and the price charged by Central did not fall to a level equal to that of the major mills until the close of 1953. Throughout the period in question, Domestic was able to sell all its first quality (or prime) steel at prices substantially in excess of cost.
The term "second quality steel" refers to steel having "defects" or conditions which render it less valuable than first quality steel. There is no established market for such steel; its selling price is established for each sale by the buyer's bid and the seller's offer. Even in times of shortage, there is some competition among sellers for the sale of their second quality merchandise. Such steel may require processing, such as "cutting" or "planning," prior to sale, and frequently can be sold only after searching for customers.
On the other hand, second quality steel is more valuable than scrap steel which is generally unsalable except to scrap dealers at regular scrap prices. Scrap dealers maintain a ready market for scrap steel.
Defects *110 or conditions causing steel to be classified as second quality, or in some instances as scrap, include the following: (a) "Laminated steel" consists of sheets of steel joined together in a manner that may not be visible until the steel is processed, at which time the steel may split, making it less valuable than a single piece. (b) "Blowholes" are holes inside a steel plate which weaken it and reduce its market value. (c) "Dropoffs" are pieces of steel irregular in size and shape which result from cutting standard size plates of first quality steel for specific orders; what is left *781 is less usable than standard size first quality plate. It may be completely unusable, in which case it is scrap. (d) "Off-gauge" steel is that steel which is not of a standard thickness customarily used in the industry; it is used only in unusual circumstances and consequently is not as salable as first quality steel. (e) "Off-analysis" steel does not contain the range of chemicals standard for steel, making it undesirable for certain applications and therefore less salable. (f) "Semikilled" steel is made of so-called rim steel which is less than prime quality. (g) Steel is also of less than prime value, *111 and may even be scrap, if it is wavy, rusty, pitted, bowed, bent, or scaly. (h) "Excess material" refers to items which are excess with respect to the producing mill. For example, the term includes "overruns," that is steel, which a mill has rolled in excess of a specific order, and which the mill sells to warehousemen at prices below the published prices for first quality products. Petitioner also used the term to describe accumulations of various items which resulted from processing operations in the warehouse. (i) Steel also has a lower value if it has been in inventory for an inordinate amount of time.
During the period of steel shortage, Domestic found that some of the steel which it purchased from Central at prime prices was in fact second quality material. Although it may have had the right to return such steel and receive credit therefor, Domestic did not do so prior to 1953, for fear of jeopardizing its position with Central which, at that time, was its only regular supplier of first quality products. Beginning in 1953, Domestic did return some second quality items that had been purchased from Central at earlier dates but had not been resold.
Since incorporation, and during *112 the taxable years in question, Domestic's inventory has been taken by Loveman and Merlin, with the assistance of shop superintendents. It was their practice to inspect visually so much of Domestic's steel as was feasibly subject to physical observation, at the same time listing the items viewed and noting any defects observed in order to distinguish between first quality steel, second quality steel, and scrap. The condition of items stored outside of the Cleveland area was determined by letter or telephone call to the person or persons responsible for them.
For purposes of computing the lower of cost or market, Loveman and Merlin customarily determined the market value of Domestic's first quality steel by reference to the prevailing mill price of the major mill producers, as published in Iron Age Magazine, a widely read trade magazine whose published prices have been stipulated in this case to be true and correct. As long as Domestic was able to purchase its requirements from such major producers, the market value of its first quality inventories, determined as *782 aforesaid, was normally equal to the cost thereof. On December 31, 1951, and December 31, 1952, however, when Domestic's *113 purchases were confined to a premium mill, the continued reference to major mill prices in determining market value resulted in Domestic's inventories of first quality steel being valued at levels substantially below cost.
On December 31, 1951, the published mill price of the major producing mills for carbon steel plate was $ 3.70 per cwt., whereas the published mill price of Central was $ 6.75 per cwt. At the close of 1951, Domestic had 4,985,385 pounds of steel on hand, most of which had been purchased from Central in December 1951. That portion of the steel which was located in Domestic's warehouse was visually inspected and determined to be all first quality. A large portion of the 1951 inventory, however, was "buried" under snow in railroad cars on sidetracks in Cleveland and was inaccessible to Domestic's employees; for inventory purposes, it was assumed that this was also first quality steel. In computing market value, Loveman and Merlin valued each of the items in Domestic's 1951 inventory at the prevailing published mill price of the major producing mills ($ 3.70 per cwt.). So determined, market was lower than cost and was used in pricing Domestic's inventory at the close *114 of 1951. One item in the inventory had been sold prior to receipt and was priced at cost.
At the beginning of 1951, Central had a rated annual capacity to produce 182,400 net tons of sheared carbon steel plate, or about 3 per cent of the total industry rated capacity of 6,888,650 net tons of such plate. During 1951, 8,281,916 net tons of sheared steel plate of all types were produced, including carbon alloy and stainless plate. Of this amount, 7,910,594 net tons were actually shipped and, of the amount shipped, 1,088,137 net tons went to steel warehousemen such as Domestic. The average value of all carbon steel plate shipped in the United States (other than interplant transfers) in 1951, including shipments by the major producing mills and the premium mills, was approximately $ 4.40 per cwt.
During 1952, 8,702,537 net tons of steel plate of all types were produced, including carbon, wrought iron, alloy, and stainless plate. Of this amount, 7,006,123 net tons (including 6,617,543 net tons of carbon plate) were actually shipped. Of the amount shipped, 1,202,591 net tons (including 1,171,118 net tons of carbon plate) went to steel warehousemen such as Domestic. The average price of *115 all carbon steel plate shipped in the United States (other than interplant transfers) in 1952 was approximately $ 4.45 per cwt.
On December 31, 1952, the published mill price of the major producers for carbon steel plate was $ 3.90 per cwt., whereas the published mill price of Central was $ 6.50 per cwt. At the close of 1952, Domestic had 6,322,433 pounds of steel on hand. Of this *783 amount, Loveman and Merlin classified the items listed below in table A, totaling 1,560,250 pounds, as first quality steel and valued each of these items at $ 3.90 per cwt.
| Table A. ($ 3.90 Per Cwt.) | ||
| PLATES | ||
| Gauge | Cost per | Weight |
| cwt. | ||
| Inches | Pounds | |
| 6 1/2 | $ 7.20 | 100,175 |
| 6 | 7.15 | 169,025 |
| 5 1/2 | 7.15 | 193,970 |
| 5 | 7.15 | 83,700 |
| 4 1/2 | 7.15 | 171,305 |
| 4 | 7.15 | 118,385 |
| 3 3/4 | 7.15 | 66,725 |
| 3 1/2 | 7.15 | 51,260 |
| 3 1/4 | 7.15 | 33,995 |
| 3 | 7.05 | 56,930 |
| 2 | 7.05 | 38,695 |
| 1 3/4 | 7.10 | 109,390 |
| 1 1/2 | 6.50 | 45,560 |
| 1 | 6.55 | 123,935 |
| 5/8 | 5.00 | 54,350 |
| 1/2 | 6.55 | 25,810 |
| 1/4 | 6.30 | 88,430 |
| 3/4 | 7.00 | 21,685 |
| 3 1/2 | 7.15 | 6,925 |
| Total | 1,560,250 |
So determined, market was lower than cost and was used in pricing Domestic's inventory of first quality steel at the close of 1952.
The items listed below in table B, totaling 3,316,910 pounds, were classified as second quality steel in the closing inventory for 1952 because of the "defects" or conditions *116 noted. Each of these items was valued at $ 3 per cwt.
| Table B. ($ 3 Per Cwt.) | |||
| PLATES | |||
| Gauge | Cost per cwt. | Weight | "Defect" |
| Inches | Pounds | ||
| 6 | $ 7.15 | 24,315 | Semi-killed. |
| 4 1/2 | 7.15 | 4,430 | Drop offs. |
| 4 | 7.15 | 47,970 | Drop offs and wavy. |
| 3 3/4 | 7.15 | 4,510 | Drop offs. |
| 3 1/2 | 7.20 | 64,290 | Semi-killed. |
| 3 | 7.05 | 10,330 | Drop offs. |
| 2 3/4 | 7.05 | 3,410 | Drop offs. |
| 2 3/4 | 6.50 | 6,605 | Drop offs. |
| 2 5/8 | 7.05 | 3,785 | Off gauge. |
| 2 1/2 | 5.00-7.05 | 61,930 | Excess of drop offs. |
| 2 1/4 | 5.00-7.05 | 23,405 | Excess of drop offs. |
| 2 3/16 | 7.05 | 8,145 | Off gauge. |
| 2 | 7.05 | 21,215 | Excess or off gauge. |
| 1 7/8 | 7.05 | 12,845 | Off gauge. |
| 1 3/4 | 6.50-7.05 | 8,800 | Drop offs. |
| 1 5/8 | 7.05 | 11,800 | Off gauge. |
| 1 1/2 | 6.50 | 94,615 | Excess material. |
| 1 7/16 | 6.30-6.50 | 8,210 | Off gauge and excess material. |
| 1 3/8 | 6.50 | 23,575 | Off gauge. |
| 1 1/4 | 5.00 | 85,440 | Excess material. |
| 1 3/16 | 6.50 | 2,175 | Off gauge. |
| 1 1/16 | 6.50 | 7,715 | Off gauge. |
| 1 | 5.00 | 342,700 | Miscellaneous and irregular. |
| 15/16 | 6.30 | 7,979 | Off gauge. |
| 7/8 | 5.00 | 169,695 | Miscellaneous and drop offs. |
| 13/16 | 5.00 | 1,875 | Off gauge. |
| 3/4 | 5.00 | 195,590 | Miscellaneous and irregular. |
| 23/32 | 6.30 | 1,550 | Off gauge. |
| 5/8 | 5.00 | 129,199 | Miscellaneous and irregular. |
| 19/32 | 6.30 | 2,502 | Off gauge. |
| 37/64 | 6.30 | 3,030 | Off gauge. |
| 9/16 | 6.30 | 3,050 | Off gauge. |
| 1/2 | 5.00 | 226,940 | Miscellaneous sizes, irregular and |
| small pieces. | |||
| 7/16 | 6.30 | 6,000 | Miscellaneous and irregular. |
| 27/64 | 6.30 | 4,172 | Off gauge. |
| 13/32 | 6.30 | 23,241 | Off gauge. |
| 25/64 | 6.30 | 20,208 | Off gauge. |
| 3/8 | 6.30 | 807,768 | Off analysis, excess and |
| miscellaneous irregulars. | |||
| 23/64 | 6.30 | 4,992 | Off gauge. |
| 11/32 | 6.30 | 36,287 | Off gauge. |
| 21/64 | 6.30 | 14,772 | Off gauge. |
| 5/16 | 6.30 | 72,425 | Excess material and seconds. |
| 19/64 | 6.30 | 37,454 | Off gauge. |
| 9/32 | 6.30-8.00 | 100,037 | Off gauge. |
| 17/64 | 6.30 | 27,808 | Off gauge. |
| 1/4 | 6.30 | 435,195 | Off analysis and off gauge. |
| 15/64 | 6.30 | 2,538 | Off gauge. |
| 7/32 | 6.30 | 66,264 | Off gauge. |
| 13/64 | 6.30 | 26,037 | Off gauge. |
| 3/16 | 6.30 | 8,087 | Drop offs and excess material. |
| Total | 3,316,910 |
*117 *784 The items listed below in table C, totaling 1,445,273 pounds, contained the following "defects" and each was valued in the closing inventory for 1952 at $ 2 per cwt., being regarded as scrap:
| Table C. ($ 2 Per Cwt.) | |||
| PLATES | |||
| Gauge | Cost per cwt. | Weight | "Defect" |
| Inches | Pounds | ||
| 10 | $ 7.20 | 45,040 | Blow holes. |
| 9 1/2 | 7.20 | 45,340 | Blow holes. |
| 9 | 7.20 | 72,740 | Blow holes. |
| 8 1/2 | 7.20 | 77,650 | Blow holes. |
| 8 | 7.20 | 78,815 | Blow holes. |
| 7 1/2 | 7.20 | 112,040 | Blow holes. |
| 7 | 7.20 | 126,665 | Blow holes. |
| 6 | 7.15 | 15,860 | Off analysis. |
| 5 | 7.15 | 5,190 | Laminated. |
| 3/16 | 5.75 | 113,750 | Off analysis. |
| 2 1/2 | 7.05 | 80,105 | Off analysis and bowed. |
| 6 | 6.95 | 104,135 | Off analysis and bowed. |
| BARS | |||
| 7/8 | 5.40 | 103,900 | Rusty. |
| 1 | 5.45 | 188,230 | Bent and rusty. |
| MISCELLANEOUS | |||
| Rounds MBQ | 3.95-5.05 | 99,090 | Odd lots and bent. |
| Bars MBQ | 5.05 | 3,392 | Cut and bent. |
| Angles | 8.235 | 107,221 | Rusty. |
| H. R. Plates | 5.00 | 66,110 | Rusty. |
| Total | 1,445,273 |
Items which were treated as scrap were not valued at the published scrap price but at a lesser figure. The published scrap price was the price paid by mills to scrap dealers who, in turn, purchased from warehousemen. The prices which scrap dealers paid to warehousemen were less than the published scrap price, reflecting costs incurred by the dealers in making the scrap suitable for mill use and the dealers' profit *118 on resale to the mills.
*785 The aforementioned values of $ 3 and $ 2 per cwt., being lower than cost, were used in pricing Domestic's inventory of items regarded as second quality and scrap at the close of 1952.
The table below sets forth all of Domestic's sales of steel plate in January and February 1953, the 2 months following the December 31, 1952, inventory date:
| Price range per | |||
| Pounds | cwt. | ||
| Gauge | sold | ||
| Low | High | ||
| Inches | |||
| 1/4 | 192,330 | $ 6.00 | $ 10.26 |
| 9/32 | 3,760 | 10.26 | 10.26 |
| 3/16 | 9,040 | 8.00 | 8.00 |
| 3/8 | 58,250 | 8.00 | 10.00 |
| 5/16 | 4,520 | 10.26 | 10.26 |
| 9/16 | 14,545 | 10.22 | 10.22 |
| 11/16 | 24,385 | 10.22 | 10.22 |
| 1/2 | 47,340 | 8.00 | 10.22 |
| 3/4 | 85,710 | 8.50 | 10.22 |
| 7/8 | 90,980 | 8.00 | 10.50 |
| 5/8 | 92,400 | 6.25 | 11.00 |
| 1 | 190,050 | 7.30 | 10.92 |
| 1 1/8 | 320 | 11.00 | 11.00 |
| 1 1/4 | 71,270 | 7.55 | 10.31 |
| 1 3/8 | 80,795 | 9.00 | 10.26 |
| 1 1/2 | 1*119 192,290 | 7.25 | 11.20 |
| 1 3/4 | 164,970 | 10.26 | 11.25 |
| 1 7/8 | 6,380 | 9.00 | 9.00 |
| 2 | 185,005 | 8.70 | 11.50 |
| 2 1/4 | 20,795 | 10.12 | 11.25 |
| 2 1/2 | 278,500 | 8.50 | 14.00 |
| 2 7/8 | 16,620 | 8.50 | 9.80 |
| 3 | 119,590 | 9.00 | 10.70 |
| 3 1/4 | 22,340 | 9.90 | 10.22 |
| 3 1/2 | 114,660 | 9.85 | 10.70 |
| 3 3/4 | 4,740 | 9.00 | 9.00 |
| 4 | 69,005 | 10.00 | 10.70 |
| 4 3/8 | 14,960 | 9.90 | 9.90 |
| 4 1/2 | 37,605 | 9.90 | 10.50 |
| 4 3/4 | 19,160 | 8.05 | 8.05 |
| 5 | 23,520 | 9.90 | 11.00 |
| 5 1/2 | 22,635 | 10.00 | 10.00 |
| 6 | 45,650 | 9.25 | 12.00 |
| 6 1/2 | 19,520 | 10.22 | 10.22 |
| 7 1/2 | 23,660 | 9.00 | 12.00 |
| 8 | 58,840 | 10.21 | 11.20 |
| 10 | 7,220 | 9.00 | 12.00 |
| Total sales for | |||
| January and | |||
| February | 2,433,360 |
During the calendar year 1953, with the exception of the aforementioned lot of 39,045 pounds sold as scrap at $ 1.79 per cwt., Domestic sold no steel plate at less than $ 4.25 per cwt. Domestic reported annual gross sales for 1953 of $ 964,995.55. The following table summarizes all sales of steel plate made by Domestic during 1953 at prices less than $ 5 per cwt.
| Date of sale | Pounds | Price per | Gross sales |
| sold | cwt. | price | |
| 1953 | |||
| February | 39,045 | $ 1.79 | $ 698.91 |
| April | 20,400 | 4.60 | 938,40 |
| April | 1 750,000 | 4.60 | 34,500.00 |
| May | 54,950 | 4.50 | 2,472.75 |
| May | 39,800 | 4.60 | 1,830,80 |
| May | 42,800 | 4.60 | 1,968.80 |
| May | 39,650 | 4.60 | 1,823.90 |
| May | 49,800 | 4.75 | 2,365.50 |
| May | 38,800 | 4.75 | 1,843.00 |
| May | 49,650 | 4.60 | 2,283.90 |
| May | 48,950 | 4.60 | 2,251.70 |
| May | 50,250 | 4.60 | 2,311.50 |
| May | 29,800 | 4.75 | 1,415.50 |
| May | 49,200 | 4.50 | 2,214.00 |
| May | 74,850 | 4.50 | 3,368.25 |
| May | 48,550 | 4.50 | 2,184.75 |
| May | 29,100 | 4.60 | 1,338.60 |
| June | 19,215 | 4.50 | 864.68 |
| June | 45,140 | 4.25 | 1,918.45 |
| June | 50,100 | 4.60 | 2,304.60 |
| November | 70,290 | 4.33 | 3,043.56 |
| Total | 1,640,340 | 73,941.55 |
On December 31, 1953, the published mill price of the major mill producers for carbon steel plate was $ 4.10 per cwt. The published mill price *120 of Central was also $ 4.10 per cwt. In taking inventory *786 at the close of 1953, Loveman and Merlin determined that Domestic had 5,396,382 pounds of steel on hand. Of this amount, they classified the items listed below in table D, totaling 1,128,613 pounds as first quality and valued each item at $ 4.10 per cwt.
| Table D. ($ 4.10 per Cwt.) | ||
| PLATES | ||
| Gauge | Cost per cwt. | Weight |
| Inches | Pounds | |
| 6 | $ 4.95 | 7,700 |
| 5 | 7.50 | 28,325 |
| 4 1/2 | 7.50 | 48,600 |
| 4 | 5.00 | 26,820 |
| 4 | 7.35 | 44,175 |
| 3 1/2 | 7.35 | 44,120 |
| 3 1/4 | 7.35 | 33,070 |
| 3 | 7.25 | 62,235 |
| 2 5/8 | 7.25 | 16,965 |
| 2 1/2 | 7.25 | 22,155 |
| 2 3/8 | 7.25 | 17,170 |
| 2 1/4 | 5.00 | 6,340 |
| 2 1/4 | 7.25 | 17,220 |
| 2 | 7.25 | 44,995 |
| 1 3/4 | 7.25 | 24,860 |
| 1 1/2 | 7.20 | 49,905 |
| 1 1/4 | 7.20 | 28,200 |
| 1 1/8 | 7.20 | 8,515 |
| 1 | 7.20 | 73,850 |
| 7/8 | 7.20 | 10,460 |
| 3/4 | 7.20 | 35,335 |
| 5/8 | 7.20 | 8,020 |
| 5/8 | 5.00 | 3,125 |
| 1/2 | 6.10 | 48,380 |
| 3/8 | 7.20 | 53,545 |
| 1/4 | 5.00 | 12,660 |
| 1/4 | 7.60 | 42,920 |
| ANGLES | ||
| 5/16 | 5.25 | 19,680 |
| 1/4 | 5.25 | 35,891 |
| CHANNELS | ||
| Pounds | ||
| 4.1 | 5.90 | 18,678 |
| 8.2 | 5.70 | 15,026 |
| 13.75 | 5.65 | 273 |
| I-BEAMS | ||
| 7.7 | 5.85 | 15,685 |
| 18.4 | 5.16 | 86,450 |
| 25.4 | 5.50 | 42,365 |
| 31.8 | 5.40 | 3,681 |
| 12.5 | 5.65 | 130 |
| W. F. BEAMS | ||
| 17 | 5.55 | 71,089 |
| Total | 1,128,613 |
So determined, market was lower than cost and was used in pricing Domestic's inventory of first quality steel at the close of 1953.
The items listed below in table E, totaling 2,205,670 pounds, were classified as second quality steel because of the conditions noted. *787 *121 Each of these items was valued at $ 3 per cwt. as of December 31, 1953.
| Table E. ($ 3 per Cwt.) | |||
| PLATES | |||
| Gauge | Cost per cwt. | Weight | "Defect" |
| Inches | Pounds | ||
| 6 | $ 7.15 | 24,315 | Irregular. |
| 5 1/2 | 7.15 | 119,055 | Unsalable. 1 |
| 5 | 7.15 | 39,820 | Unsalable. 1 |
| 4 1/2 | 7.15 | 137,285 | Unsalable. 1 |
| 4 | 7.15 | 81,905 | Unsalable. 1 |
| 3 3/4 | 7.15 | 28,520 | Unsalable. 1 |
| 3 5/8 | 7.15 | 35,310 | Unsalable. 1 |
| 3 1/2 | 7.15 | 58,225 | Rejects and unsalable. |
| 3 1/4 | 5.00 | 6,230 | Unsalable. 1 |
| 3 | 7.05 | 925 | Unsalable. 1 |
| 2 5/8 | 5.00 | 31,325 | Off gauge. |
| 2 1/2 | 7.05 | 137,638 | Unsalable. 1 |
| 2 3/8 | 5.00 | 9,475 | Off gauge. |
| 2 | 5.00 | 5,180 | Unsalable. 1 |
| 2 | 4.10 | 8,490 | Unsalable. 1 |
| 2 | 7.05 | 5,210 | Unsalable. 1 |
| 1 7/8 | 7.05 | 4,475 | Off gauge.1 |
| 1 7/8 | 5.00 | 11,390 | Off gauge. |
| 1 3/4 | 5.00 | 79,840 | Off gauge and unsalable. |
| 1 5/8 | 7.05 | 8,340 | |
| 1 5/8 | 5.00 | 16,815 | Off gauge. |
| 1 1/2 | 5.00 | 28,935 | Unsalable. 1 |
| 1 1/2 | 6.50 | 50,015 | Unsalable. 1 |
| 1 7/16 | 6.50 | 1,590 | Off gauge. |
| 1 3/8 | 5.00 | 9,675 | Off gauge. |
| 1 1/4 | 5.00 | 47,175 | Unsalable. |
| 1 3/16 | 6.50 | 2,175 | Off gauge. |
| 1 1/8 | 6.50 | 62,870 | Off gauge. |
| 1 1/16 | 6.50 | 5,555 | Off gauge. |
| 1 | 6.55 | 117,575 | Unsalable. 1 |
| 1 | 5.00 | 183,940 | Unsalable. 1 |
| 15/16 | 6.30 | 7,979 | Off gauge. |
| 7/8 | 5.00 | 59,725 | Off gauge. |
| 7/8 | 6.50 | 55,815 | Off gauge. |
| 13/16 | 5.00 | 1,875 | Off gauge. |
| 3/4 | 5.00 | 48,420 | Unsalable. 1 |
| 3/4 | 6.50 | 52,560 | Unsalable. 1 |
| 5/8 | 4.95 | 104,415 | Unsalable. 1 |
| 1/2 | 5.00 | 55,730 | Unsalable. 1 |
| 27/64 | 6.30 | 4,172 | Off gauge. |
| 13/32 | 6.30 | 12,230 | Off gauge. |
| 25/64 | 6.30 | 842 | Off gauge. |
| 3/8 | 5.35 | 8,320 | Unsalable. 1 |
| 3/8 | 4.95 | 13,460 | Unsalable. 1 |
| 3/8 | 6.30 | 182,000 | Unsalable. 1 |
| 23/64 | 6.30 | 1,182 | Off gauge. |
| 1/2 | 6.55 | 9,550 | Unsalable. 1 |
| 11/32 | 6.30 | 11,222 | Off gauge. |
| 21/64 | 6.30 | 10,665 | Off gauge. |
| 5/16 | 6.30 | 56,881 | Unsalable. 1 |
| 19/64 | 6.30 | 24,974 | Off gauge. |
| 17/64 | 6.30 | 1,180 | Off gauge. |
| 1/4 | 5.00 | 31,216 | Unsalable. 1 |
| 3/16 | 5.00 | 80,005 | Unsalable. 1 |
| I-BEAMS | |||
| Pounds | |||
| 12.5 | 5.65 | 11,979 | Flange. |
| Total | 2,205,670 |
The items listed below in table F, totaling 1,935,502 pounds, contained the following "defects" and each item was valued in the closing inventory for 1953 at $ 1 per cwt., being treated as scrap. *788
| Table F. ($ 1 per Cwt.) | |||
| PLATES | |||
| Gauge | Cost per cwt. | Weight | "Defect" |
| Inches | Pounds | ||
| 10 | $ 7.20 | 16,940 | Blow holes and drop offs. |
| 9 1/2 | 7.20 | 45,340 | Blow holes. |
| 9 | 7.20 | 61,925 | Blow holes. |
| 8 1/2 | 7.20 | 55,545 | Blow holes. |
| 8 | 7.20 | 32,280 | Blow holes. |
| 7 1/2 | 7.20 | 51,410 | Blow holes. |
| 7 | 7.20 | 118,825 | Blow holes. |
| 6 1/2 | 7.20-7.65 | 94,805 | Blow holes. |
| 6 | 4.00 | 58,480 | Blow holes. |
| 6 | 7.15 | 125,775 | Blow holes. |
| 5 | 7.15 | 750 | Drop offs. |
| 4 1/2 | 7.15 | 290 | Drop offs. |
| 4 1/2 | 7.15 | 8,900 | Drop offs. |
| 4 | 7.15 | 2,910 | Drop offs. |
| 4 | 5.00 | 4,070 | Drop offs. |
| 3 1/2 | 7.15 | 1,500 | Drop offs. |
| 3 1/4 | 5.00 | 4,845 | Drop offs. |
| 3 | 7.05 | 6,640 | Drop offs. |
| 2 | 7.50 | 10,950 | Drop offs. |
| 9/16 | 4.00 | 120,350 | Off gauge. |
| 7/32 | 5.00 | 18,680 | Off gauge. |
| 5 1/2 | 7.50 | 6,950 | Drop offs. |
| 5 | 4.95 | 3,175 | Drop offs. |
| 4 | 5.00 | 11,695 | Drop offs. |
| 3 1/4 | 7.35 | 8,350 | Drop offs. |
| 3 | 5.00 | 7,940 | Drop offs. |
| 2 1/2 | 7.25 | 3,980 | Drop offs. |
| 2 | 7.25 | 950 | Drop offs. |
| 1 1/4 | 7.20 | 6,690 | Drop offs. |
| 1 1/8 | 7.20 | 9,200 | Drop offs. |
| 1/2 | 7.20 | 1,245 | Drop offs. |
| CHANNELS | |||
| Pounds | |||
| 28.5 | 4.00 | 3,922 | Rusted and pitted. |
| HEXAGONS | |||
| Inches | |||
| 13/16 | 2.00 | 200,400 | Unsalable. 1 |
| ROUNDS | |||
| 3/4 | 2.00 | 17,352 | Off analysis and off gauge. |
| 1 3/16 | 2.00 | 4,218 | Off analysis and off gauge. |
| 15/16 | 2.00 | 2,490 | Off analysis and off gauge. |
| 2 3/16 | 2.00 | 3,470 | Off analysis and off gauge. |
| 2 7/16 | 2.00 | 1,420 | Off analysis and off gauge. |
| 2 1/2 | 2.00 | 4,185 | Off analysis and off gauge. |
| 2 1/2 | 3.50 | 27,150 | Seams. |
| 3 | 3.50 | 49,310 | Seams. |
| REENFORCING BARS | |||
| 4.00 | 690,200 | Rusted and pitted. | |
| H. R. ROUNDS | |||
| 3.75 | 30,000 | Rusted and pitted. | |
| Total | 1,935,502 |
In addition, a single item consisting of 126,597 pounds of 9/32-inch steel plate, with a cost of $ 5 per cwt., was valued at $ 2 per cwt. *789 The aforementioned values of $ 3, $ 1, and $ 2 per cwt., being lower than cost, were used in pricing items classified as second quality steel and scrap at the close of 1953.
The table below sets forth all of Domestic's sales of steel plate in January and February 1954, the 2 months following the December 31, 1953, inventory date:
| Price range per cwt. | |||
| Gauge | Pounds | ||
| sold | |||
| Low | High | ||
| Inches | |||
| 1/4 | 11,240 | $ 6.70 | $ 7.10 |
| 3/8 | 21,250 | 5.00 | 7.15 |
| 3/16 | 500 | 6.70 | 12.00 |
| 1/2 | 6,420 | 6.50 | 7.20 |
| 9/16 | 7,200 | 5.50 | 5.50 |
| 3/4 | 12,000 | 6.50 | 6.50 |
| 5/8 | 20,480 | 5.36 | 12.00 |
| 1 | 56,550 | 5.36 | 9.60 |
| 1 1/4 | 3,600 | 9.00 | 9.00 |
| 1 3/8 | 35,650 | 6.50 | 6.50 |
| 1 1/2 | 53,270 | 6.50 | 7.20 |
| 1 3/4 | 19,240 | 6.70 | 7.60 |
| 2 | 11,740 | 6.50 | 10.15 |
| 2 1/8 | 3,090 | 6.70 | 6.70 |
| 2 1/4 | 10,170 | 6.70 | 9.00 |
| 2 1/2 | 15,940 | 7.55 | 10.15 |
| 2 3/4 | 3,000 | 6.50 | 6.50 |
| 2 5/8 | 1,690 | 7.80 | 7.80 |
| 3 | 9,000 | 7.75 | 7.75 |
| 3 1/2 | 8,830 | 7.75 | 7.75 |
| 4 | 12,260 | 6.50 | 12.00 |
| 4 1/2 | 2,190 | 6.50 | 8.80 |
| 5 | 18,740 | 7.25 | 8.45 |
| 5 1/2 | 28,880 | 6.70 | 8.45 |
| 6 | 2,810 | 6.50 | 6.50 |
| 6 1/2 | 5,760 | 6.50 | 7.45 |
| 7 | 20,880 | 7.80 | 7.80 |
| 8 | 11,320 | 7.50 | 7.50 |
| 8 1/2 | 840 | 6.50 | 6.50 |
| 9 | 4,160 | 6.50 | 6.50 |
| 10 | 1,330 | 7.65 | 7.65 |
| Total | 420,030 |
*124 During the calendar year 1954, Domestic sold no steel plate at less than $ 3.25 per cwt. Domestic reported annual gross sales for 1954 of $ 337,783.31. The following table summarizes all sales of steel plate made by Domestic during 1954 at prices less than $ 5 per cwt.
| Date of sale | Pounds | Price per | Gross sales |
| sold | cwt. | price | |
| 1954 | |||
| March | 7,460 | $ 4.85 | $ 361.81 |
| March | 17,440 | 4.85 | 845.84 |
| April | 33,660 | 4.85 | 1,632.51 |
| April | 3,730 | 4.85 | 180.91 |
| June | 60,100 | 3.50 | 2,103.50 |
| July | 11,470 | 4.70 | 539.09 |
| July | 47,660 | 3.25 | 1,548.95 |
| August | 59,811 | 3.50 | 2,093.39 |
| August | 48,600 | 4.77 | 2,318.22 |
| September | 11,170 | 4.85 | 541.75 |
| December | 1,490 | 4.63 | 68.99 |
| December | 20,690 | 4.65 | 962.09 |
| December | 14,730 | 4.25 | 626.03 |
| December | 32,648 | 4.55 | 1,485.48 |
| December | 23,620 | 4.15 | 980.23 |
| Total | 394,279 | 16,288.79 |
The record does not disclose whether the sale in February 1953, of 39,045 pounds of 1 1/2-inch plate at $ 1.79 per cwt., was made out of Domestic's 1952 closing inventory, or whether that item was purchased after December 31, 1952. With the possible exception of that item, however, none of the items treated as scrap in Domestic's inventories of either 1952 or 1953 was in fact sold at scrap prices. To the contrary, the great majority of such items were subsequently sold by Domestic at prices substantially *125 above the scrap values of $ 2 and $ 1 per cwt. attributed to them by Loveman and Merlin. For example, most of the inventory items classified as scrap at the close of 1953 were gradually liquidated in 1954 and *790 1955 at prices generally ranging from about $ 5.50 to $ 8.50 per cwt., and occasionally ranging as high as $ 10.63 per cwt., $ 10.70 per cwt., and $ 12.09 per cwt. The lowest sales price shown for a 1953 inventory item classified as scrap was for 120,350 pounds of 9/16-inch plate which was completely disposed of in 1954 at prices which ranged from a low of $ 3.25 per cwt. to a high of $ 8.80 per cwt.
Although there was no established market for second quality steel, Domestic succeeded during 1953, 1954, and 1955 in gradually disposing of almost all the items classified as second quality in its closing inventories of 1952 and 1953, at prices substantially higher than the value of $ 3 per cwt. attributed to them by Loveman and Merlin for inventory purposes. In most instances, those items were sold within a price range approximating or exceeding the cost of those items. Prices ranging between $ 5.50 and $ 9 were typical. In some instances, selling prices ranged as high as $ 10.15, *126 $ 10.65, $ 10.70, $ 10.89, $ 10.90, $ 11.15, and $ 12 per cwt. The lowest sales price shown for a 1953 inventory item of second quality steel plate was for 1,182 pounds of 23/64-inch plate which was sold on December 8, 1954, at $ 4.25 per cwt.
The major producing mills also served as Export's customary source of supply, but as of the spring of 1953 Export was unable to obtain any steel from those mills. Export was not able to purchase steel from a major mill until September or October 1953. Consequently, Loveman went to Europe in June 1953 to purchase structural steel products on behalf of Export.
By the close of Export's fiscal year ended August 31, 1953, some of the steel purchased in Europe was in Export's warehouse, and the remainder was en route. In taking inventory as of August 31, 1953, the items in Export's warehouse were determined to be all first quality, and it was assumed that the merchandise in transit was also first quality.
For purposes of computing the lower of cost or market, Loveman and Merlin customarily determined the market value of Export's first quality steel by reference to the published mill price of the major mill producers for the type of steel involved. *127 On August 31, 1953, Export had 1,787,930 pounds of steel on hand, representing a total inventory cost of $ 103,367.97, or an average inventory cost of $ 5.79 per cwt. The prevailing published mill prices of the major producers for the structural steel products constituting this inventory were $ 4.15 per cwt. and $ 4.10 per cwt. divided as follows:
| Amount | Published major | |
| pounds | mill price | |
| 1,385,596 | $ 4.10 per cwt. | |
| 402,334 | 4.15 per cwt. | |
| Total | 1,787,930 |
*791 On the basis of these major mill prices, market was lower than cost and was used in pricing Export's fiscal 1953 inventory.
On August 31, 1953, Export sold 26,177 pounds of angles and channels to Domestic at a price of $ 2,185.01, or $ 8.35 per cwt. During September 1953, Export made further sales to Domestic as follows:
| Date | Amount | Gross sales | Selling price |
| price | per cwt. | ||
| 1953 | Pounds | ||
| Sept. 10 | 42,714 | $ 3,167.57 | $ 7.42 |
| Sept. 18 | 65,050 | 4,806.55 | 7.39 |
| Sept. 24 | 12,619 | 1,010.95 | 8.01 |
| Sept. 30 | 33,908 | 2,575.40 | 7.60 |
Export did not purchase any steel during fiscal 1954. As of August 31, 1954, Export had 888,493 pounds of steel on hand -- all of which had been carried over from the inventory of August 31, 1953 -- representing a total inventory cost of $ 49,880.54, or an average inventory *128 cost of $ 5.61 per cwt.
None of the items in Export's inventory as of August 31, 1954, was classified as first quality by Loveman and Merlin. Various lots of steel angles, totaling 500,610 pounds, were classified as second quality steel, allegedly because they were "becoming rusted and pitted" from outside storage; these items were valued at $ 3 per cwt. Other items, consisting of H-beams, channels, rounds, and I-beams, totaling 387,883 pounds, were classified as scrap, allegedly because they were "rusty, pitted, * * * heavily scaled" and were generally in a worse condition than the items classified as second quality; these items were valued at $ 1 per cwt. So determined, market was lower than cost and was used in pricing Export's fiscal 1954 inventory.
The record does not show the prices at which Export sold items included in its inventory of August 31, 1954. However, on August 31, 1954, Export made the following two sales to Domestic:
| Amount | Gross sales | Selling price |
| price | per cwt. | |
| Pounds | ||
| 40,780 | $ 2,985.89 | $ 7.32 |
| 10,940 | 527.31 | 4.83 |
On July 30, 1954, Export sold 59,541 pounds of steel to Domestic at a price of $ 3,794.87, or $ 6.38 per cwt. During July 1954, Export also made the following sales *129 to a company named Wallack Brothers:
| Gross sales | Selling | ||
| Date | Amount | price | price per |
| cwt. | |||
| 1954 | Pounds | ||
| July 1 | 8,050 | $ 402.50 | $ 5 |
| July 26 | 28,220 | 1,128.80 | 4 |
*792 Respondent determined in his deficiency notice that the values used by Domestic in pricing its closing inventories for 1951, 1952, and 1953 were erroneous; in recomputing taxable income, respondent priced those inventories at cost. On brief, respondent concedes, with respect to 1953, that $ 4.10 was the appropriate market value for determining the lower of cost or market of Domestic's first quality inventory, and that that value was lower than cost. He has not, however, abandoned his determination for 1953 with respect to the values used by Domestic in pricing the items which it classified as second quality and scrap.
In his deficiency notice to Export, respondent similarly determined that the values used in pricing the closing inventories of August 31, 1953, and August 31, 1954, were erroneous; in recomputing taxable income, he priced those inventories at cost.
Since incorporation, Domestic has treated its "freight-in" expenditures as a current expense on its books and on its income tax returns. Prior to 1951, Domestic did not have significant expenses *130 for "freight-in" because most of its steel was shipped directly to its customers from the producing mills. Respondent determined that the amount of "freight-in" applicable to the items in Domestic's inventories at the close of 1951, 1952, and 1953, respectively, should have been accounted for as an additional cost of those inventories rather than as a current expense.
With respect to 1951, respondent's agent was able to trace the precise amount of "freight-in" applicable to each item in closing inventory, and Domestic has stipulated that respondent's computation of the total "freight-in" expense applicable to that inventory is correct. The language of the stipulation is as follows:
The cost of bringing to Petitioner the material which constituted its inventory on December 31, 1951 was $ 27,106.09, which consisted of long distance freight charges of $ 25,929.89 and local hauling charges of $ 1,176.20.
With respect to 1952 and 1953, however, respondent's agent found it impractical, because of the manner in which Domestic's records were kept, to trace the precise amount of "freight-in" applicable to individual inventory items. Instead, he determined that the "freight-in" applicable to *131 the 1951 inventory ($ 27,106.09) represented approximately 10 per cent of the total cost of that inventory, exclusive of "freight-in," and then applied that percentage to the cost of Domestic's 1952 and 1953 inventories, respectively, in order to determine applicable "freight-in" for those years.
According to a joint exhibit submitted by the parties, the cost of Domestic's 1951 inventory, exclusive of "freight-in," was $ 338,809.99. The stipulated "freight-in" applicable to Domestic's 1951 *793 inventory ($ 27,106.09) is approximately 8 per cent of that amount, compared with the 10 per cent figure derived by the agent. Neither party has attempted to explain this apparent discrepancy, nor has Domestic raised any objection as such to the accuracy of the agent's arithmetic.
During 1952 and 1953, Domestic received almost 100 per cent of its steel by truck from Harrisburg, Pennsylvania. During 1952, the freight rate by truck from Harrisburg to Cleveland was 45 cents per cwt.; during 1953, it was 45 1/2 cents per cwt.
All of the steel not shipped to Domestic by truck was shipped by rail from Harrisburg and, on occasion, from Delaware and Johnstown, Pennsylvania. During 1952, the rail freight *132 rate from Harrisburg to Cleveland was 64 cents per cwt., from Johnstown it was 35 to 40 cents per cwt., and from the Eastern seaboard it was 70 cents per cwt. In 1953, these rail rates were raised by 15 per cent.
Merlin estimated that based on these rates the cost to Domestic of transporting steel during 1952 and 1953 was approximately 6 per cent of the total cost of the steel purchased during those years. This estimate did not include any amount for "local hauling charges" such as those stipulated for 1951.
Additional joint exhibits submitted by the parties show that the costs of Domestic's 1952 and 1953 inventories, exclusive of "freight-in," were $ 398,525.11 and $ 310,546.81, respectively. If the number of pounds of steel in Domestic's 1952 inventory (6,322,433) is multiplied by the 1952 truck rate (45 cents per cwt.), the resultant figure is $ 28,450.95, which is approximately 7 per cent of the 1952 inventory cost ($ 398,525.11), exclusive of "freight-in." Similarly, if the number of pounds of steel in Domestic's 1953 inventory (5,396,382) is multiplied by the 1953 truck rate (45 1/2 cents per cwt.), the resultant figure is $ 24,553.54, which is approximately 8 per cent of the *133 1953 inventory cost ($ 310,546.81), exclusive of "freight-in." There is no basis in the record for reconciling these percentages with the figure of 6 per cent estimated by Merlin as the ratio of applicable "freight-in" to the cost of inventory, exclusive of "freight-in," in 1952 and 1953, respectively.
Export's books and records for its fiscal year ended August 31, 1954, contained two accounts labeled, "Accounts Payable D. Loveman & Son, Inc.," showing the following balances and interest items:
| Date | Principal | Interest |
| Aug. 31, 1953 | $ 173,720.86 | $ 868.60 |
| Sept. 30, 1953 | 142,878.07 | 714.39 |
| Oct. 31, 1953 | 140,968.46 | 704.84 |
| Nov. 30, 1953 | 145,654.64 | 727.27 |
| Dec. 31, 1953 | 105,370.33 | 526.85 |
| Jan. 31, 1954 | 106,068.36 | 530.34 |
| Feb. 28, 1954 | 106,664.23 | 533.32 |
| Mar. 31, 1954 | 101,192.82 | 505.97 |
| Apr. 30, 1954 | 101,861.23 | 509.30 |
| May 31, 1954 | 102,499.72 | 512.50 |
| June 30, 1954 | 103,104.25 | 515.52 |
| July 31, 1954 | 103,696.43 | 518.48 |
| Total | 7,168.38 |
*794 The varying balances of "Principal" shown above reflected certain advances from Domestic to Export and numerous other transactions between the two corporations whereby each purchased steel from, and sold steel to, the other. Prior to 1954, neither Export nor Domestic charged the other interest on any outstanding *134 balances of intercorporate indebtedness resulting from such transactions. In the summer of 1954, however, it was decided at an informal "discussion" among Domestic's stockholders that Domestic should charge interest to Export at the rate of 6 per cent per annum, to be computed on the unpaid balance of principal at the end of each month, effective retroactively to September 1, 1953. As of the summer of 1954, Loveman, his wife, his father, and his mother owned all the stock of Domestic and an undisclosed percentage of the stock of Export. The remainder of Export's stock was held by Merlin and four other persons whose percentage of ownership is similarly undisclosed by the record.
During 1954, Domestic was receiving interest of 3 or 4 per cent from Loveman on personal loans which it had made to him on open account and which exceeded $ 200,000 in amount. Loveman's personal residence, which had an original cost to him of about $ 25,000, was mortgaged as partial security for these loans, and an unspecified amount of his stock in Domestic was pledged as additional security therefor. At this time, Domestic was paying 6 per cent on money which it had borrowed.
Export's alleged interest liability *135 to Domestic, computed as aforesaid, was entered on Export's books retroactively to September 1, 1953, and was deducted by Export on its return for the fiscal year ended August 31, 1954, in the total amount of $ 7,168.38. Export subsequently paid that amount to Domestic and Domestic reported it as income on its calendar year 1954 return. No part of the interest obligation accrued by Export was reported by Domestic as income on its calendar year 1953 return. Respondent disallowed the interest deduction claimed by Export.
In 1952, Export built a warehouse on land adjacent to Perkins Road in Bedford Heights, Ohio. Perkins Road at that time was a dead end dirt road, open to public use; it was not a private road. During its fiscal year ended August 31, 1953, Export expended $ 8,279.29 toward the cost of paving Perkins Road. Export's warehouse premises would have been inaccessible by truck without such paving.
Other owners of commercial property located on Perkins Road at the time also contributed toward the cost of paving, as did subsequent property owners who refunded to Export a portion of its previous expenditures. Export adjusted its original cost basis for the paving to reflect *136 such refunds.
*795 Initially, attempts were made to have the Village of Bedford Heights do the paving, but it refused. Since the paving of the road in 1953, it has not required any repairs. There are no lights on it. Export has its own tractor for removing snow from the road.
In its returns for the fiscal years ended August 31, 1953, and August 31, 1954, respectively, Export claimed depreciation deductions based on a 20-year useful life for the road. Respondent disallowed those deductions.
OPINION.
1. Valuation of First Quality Inventory. -- We think petitioners erred, during the taxable years in question, in continuing to value their first quality inventories by reference to the published mill price of the major mill producers.
Section 22(c), I.R.C. 1939, provides for the use of inventories by taxpayers "upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income." Pursuant to this delegation, the Commissioner has approved the method of valuing inventories at the lower of cost or market, Regulations 111, section 29.22(c)-2, Regulations *137 118, section 39.22(c)-2, and has further provided in Regulations 111, section 29.22(c)-4, and Regulations 118, section 39.22(c)-4(a), that:
Under ordinary circumstances and for normal goods in an inventory, "market" means the current bid price prevailing at the date of the inventory for the particular merchandise in the volume in which usually purchased by the taxpayers * * *
The parties are in basic disagreement as to what petitioners' "market" was during the years involved herein. Petitioners argue that the "combination of unusual circumstances" which "temporarily prevented [them] from buying their steel requirements from their usual sources did not effect any change in [their] market for inventory valuation purposes, nor require them to change their customary method of inventory valuation." In support of this contention, they point out that the major mills produced "close to 100 per cent" of all the carbon steel plate rolled in the United States, and that the determination of market value by reference to the published prices of those mills was not only "consistent with petitioners' prior practice, but * * * customary in the steel warehouse business."
Respondent, on the other hand, *138 maintains that the term "particular merchandise," as used in the above-quoted regulation, refers only to the steel which was available to the petitioners during the taxable years in question and, therefore, that petitioners' market did *796 not include steel produced by the major mills. The record, viewed in the light of applicable precedent, compellingly supports respondent's position on this issue.
With respect to first quality merchandise, the term "market," in the phrase "lower of cost or market," means the price which petitioners would have had to pay to replace items in their inventories on the applicable inventory dates. Conversely, it does not mean the price at which such merchandise is resold or offered for resale. Elder Mfg. Co. v. United States, 10 F. Supp. 125 (Ct. Cl.); Ideal Reversible Hinge Co., 7 B.T.A. 1066; see also Frederick A. Stearns, 8 B.T.A. 884, 887; Charles N. Winship, 10 B.T.A. 237, 240. This point is recognized in the regulations by the specific reference therein to "bid price * * * for the particular merchandise in the volume in which usually purchased by the taxpayer * * *." (Emphasis supplied.) In short, we are concerned here with petitioners' replacement*139 market and not their resale market.
It is clear that as late as August 31, 1953, petitioners were unable to purchase steel from the major mill producers. Loveman testified specifically that after the fall of 1951 neither Export nor Domestic was able to purchase steel from a major mill until September or October of 1953. And Central's price for carbon steel plate did not drop to a level equal to that of the major mills until the close of 1953. Thus, in determining the market for petitioners' prime inventory items as of December 31, 1951, December 31, 1952, and August 31, 1953, it would be catering to fiction rather than fact to refer, as petitioners did, to the prevailing prices charged by the major mills. As of the foregoing inventory dates, those mills represented an inaccessible purchase market to petitioners.
The fact that Central's rated capacity for sheared carbon steel plate at the beginning of 1951 was only about 3 per cent of the total industry rated capacity for such plate does not affect our conclusion in this regard. The greater percentage of national capacity represented by the major mills remained unavailable to petitioners, and constituted a market distinct from that *140 in which petitioners purchased. Petitioners' position was not unique in the steel warehousing industry; at no time did Domestic take more than 10 per cent of Central's output, and Central was only one of a number of premium mills. Moreover, steel purchased at premium prices was not in fact competitive with steel purchased at major mill prices during most of the period in question. At the close of 1951, the demand for steel was sufficiently great to absorb all of Domestic's first quality inventory at the full 50 per cent markup over premium cost permitted by C.P.R. 98. Thus, first quality steel purchased from a premium mill had an economic dimension significantly different from *797 otherwise identical steel purchased from a major mill at lower costs; the former could readily be resold at about $ 10 per cwt. (50 per cent over premium cost) whereas the resale price for the latter was limited to about $ 6 per cwt. (50 per cent over major mill cost). After C.P.R. 98 was withdrawn in March 1953, and throughout the remainder of the period involved herein, petitioners still had no difficulty in disposing of their prime steel at a substantial profit, even though demand was gradually declining *141 from its exceptionally high Korean war levels. In any event, regardless of the fluctuations of demand for steel, petitioners' replacement market did not encompass the major mills until September or October of 1953, and it is that replacement market which should have controlled the inventory valuation of petitioners' first quality merchandise for the inventory dates prior thereto.
Petitioners have devoted a considerable portion of their brief to the argument that the temporary dislocation of their regular sources of supply, caused by the Korean conflict, is an insufficient reason for changing the basis consistently used by them in pricing their inventories, that is, cost or major mill price, whichever is lower. They state that respondent's adjustments have, in effect, placed petitioners on a strictly cost basis for pricing inventory, ignoring the alternative basis of market. We disagree.
It is indeed true that the Commissioner's regulations attach greater weight to consistency than to any particular method of inventorying or basis of valuation, but only so long as the method or basis used clearly reflects income. 1 In our judgment, petitioners' continued reference during the years *142 in question to major mill prices as a basis for valuing first quality inventory actually distorted income for those years.
Moreover, petitioners are not accurate *143 in asserting that the method of valuing inventories during the tax years was consistent with the method previously employed. It was consistent only in the misleading sense that market values were determined by the posted prices *798 of the major producing mills. But, in the period prior to the tax years petitioners actually bought their steel from the major producing mills and the posted prices of such mills in fact accurately represented the market price for the steel in the very market that petitioners acquired it. In contrast, during the period in controversy, that market was closed to petitioners, and it is highly fallacious to contend that petitioners were consistently employing the same method. They were not because, during the period in controversy, they were not relating market values to the market in which they bought or could buy their inventory.
Whatever the defects of the lower of cost-or-market method in actual practice, its underlying theory, as stated in Finney and Miller, Principles of Accounting (Intermediate) (5th ed. 1958), is as follows (p. 251):
The cost-or-market basis of inventory pricing conforms with an old rule of accounting conservatism often stated as follows: *144 Anticipate no profit and provide for all possible losses. If market purchase prices decline, it is assumed that selling prices will decline with them; reducing the inventory valuation to market purchase price reduces the profit of the period when the cost price decline took place and transfers the goods to the next period at a price which will presumably permit the earning of a normal gross profit on their sale. If the market purchase price increases, the inventory is valued at cost so that a profit will not be anticipated.
Petitioners' continued use of major mill prices in determining market represents an application of the cost-or-market method which is wholly inconsistent with the theory of that method as above expounded. By the automatic reduction of inventory values from cost to major mill price, petitioners provided for losses which were not in fact anticipated. As previously pointed out, petitioners at all relevant times were able to dispose of their first quality items at prices 50 per cent above premium cost or, in any event, at prices substantially exceeding such cost.
Contrary to petitioners' contention, it is respondent's valuation of the inventories in question that *145 more closely complies with the lower of cost or market method. As long as petitioners were able to purchase their requirements from the major producers, actual cost and replacement cost (i.e., market) for first quality merchandise were normally the same. This is so because petitioners were usually able to resell their prime inventory before any dramatic decline in major mill prices. The same situation prevailed during the years involved herein with respect to petitioners' inventories of first quality steel purchased at premium prices. Thus, petitioners' replacement cost for prime steel approximated actual cost at all times relevant to disposition of the issue at hand, and respondent's determinations, based on actual cost, reflect this fundamental fact.
*799 Our conclusion on this issue is based on the proposition that market value, even for inventory purposes, must be related to relevant facts and market conditions prevailing as of the date such value is to be determined. The instant case is analogous to E. T. Bamert, 8 B.T.A. 1099, where the taxpayer, a sheep grower in San Joaquin County, California, inventoried his ewes by the farm price method, using the price per head prevailing *146 in San Joaquin County at the close of each year. The respondent in that case adjusted the taxpayer's valuation of inventory on the basis of values taken from other States and "somewhat distant localities." We disapproved respondent's adjustments, stating as follows at page 1100:
Petitioner was located in, or near, central California. There he bought and sold his sheep. That locality was his market, and it is by the prices of that market, and not some distant one, that the value of his goods should be fixed. * * *
In a like sense, petitioners' market during the years in question did not encompass the major mills, and we can find no factual underpinning for the valuation of its first quality inventories by reference to major mill prices. Cf. Jacob J. Cooley, 33 T.C. 223.
Accordingly, respondent's revaluation of petitioners' prime inventories as of December 31, 1951, December 31, 1952, and August 31, 1953, must be sustained.
2. Valuation of Items Classified as Second Quality Steel and Scrap. -- Petitioners' inventories of items classified as second quality steel and scrap developed in part from the in-warehouse processing of first quality items; in the case of Domestic at least, other *147 second quality material developed from merchandise purchased as first quality, but which was discovered upon subsequent inspection or processing to be defective. With the exception of material designated as mill "excess" or "overruns," 2 it appears on this record that most steel rolled by producing mills is sold to warehousemen or dealers as first quality. Thus, there is in general no replacement market to which we may refer in determining, for inventory purposes, the market value of second quality and scrap items. In these circumstances, Regulations 111, section 29.22(c)-2, and Regulations 118, section 39.22(c)-2(c), provide as follows with respect to the valuation of such merchandise:
Any goods in an inventory which are unsalable at normal prices or unusable in the normal way because of damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes, including second-hand goods taken in exchange, should be valued at bona fide selling prices less direct cost of disposition, * * * but in no case shall such value be less than the scrap value. Bona fide selling price means actual offering of goods during a period *800 ending not later than 30 days after *148 inventory date. The burden of proof will rest upon the taxpayer to show that such exceptional goods as are valued upon such selling basis come within the classifications indicated above, and he shall maintain such records of the disposition of the goods as will enable a verification of the inventory to be made.
The only inventories in which petitioners allege they had second quality steel or scrap are those of Domestic as of December 31, 1952, and December 31, 1953, and that of Export as of August 31, 1954. After careful examination of the evidence and testimony of record, and bearing in mind that the burden of proof with respect to market value is upon petitioners, we have concluded that the values accorded by Loveman and Merlin to the inventory items in question did not represent "bona fide selling prices less direct cost of disposition," as required by the applicable regulations.
Merlin's testimony attempted to establish that petitioners priced *149 their second quality items "at what we thought we could sell it for." Apart from his evasiveness at various points which shook our confidence in him as a reliable witness, our difficulty in accepting this testimony as accurate stems from several factors, all clearly established by the record:
(1) The value of $ 3 per cwt. accorded to petitioners' second quality merchandise cannot be reconciled with typical prices at which such merchandise was ultimately sold. Exhibits compiled by Merlin himself, or under his supervision, show that Domestic succeeded in disposing of most of its second quality items at prices ranging between $ 5.50 and $ 9 per cwt., occasionally ranging even higher. And it should be noted that these prices were obtained during a period which included 1953, 1954, and 1955, when the demand for steel was declining from the exceptionally high levels of the Korean war years. The lowest selling price shown for a 1953 inventory item classified as second quality was $ 4.25 per cwt. If the differential between inventory price and actual selling prices were less dramatic, we might perhaps conclude that Merlin's testimony was reliable and that the values accorded to petitioners' *150 second quality inventories merely represented conservative estimates of bona fide selling prices. But the differential being so substantial, and lacking a satisfactory explanation therefor, we cannot reasonably reach that conclusion.
(2) Petitioners priced each of its second quality items at $ 3 per cwt., regardless of the type of defect involved. Given the wide range of selling prices shown on the aforementioned exhibits, it is difficult to comprehend why a uniform value was accorded to each second quality inventory item, unless such value was not in fact based on bona fide selling prices. In this connection, Regulations *801 111, section 29.22(c)-4, and Regulations 118, section 39.22(c)-4(c), require that --
Where inventory is valued upon the basis of cost or market, whichever is lower, the market value of each article on hand at the inventory date shall be compared with the cost of the article, and the lower of such values shall be taken as the inventory value of the article. [Emphasis supplied.]
(3) Merlin's testimony itself occasionally departed from his original position that the inventory value of $ 3 per cwt. was based on bona fide selling prices. For example, under questioning *151 by the Court, Merlin pointed out that certain excess material could be purchased as such from the mill at cost prices below those of first quality items. He then testified as follows:
THE COURT: These prices that you fixed -- that is the prices you fixed under $ 3.90, are they actually comparable to the prices that you in fact sold such pieces for at or around that time or does the price that you fix represent some sort of mental value that you put on this?
THE WITNESS: No, it is not mental value, it is what you feel is a fair market value based on the condition and the size of the material, and as I mentioned just a little while ago, it is also in relation to the mill price for excess material -- into which category something like that might fall or would fall. [Emphasis supplied.]
Of course, to the extent that second quality merchandise was priced in relation to mill prices for excess material, such value would be in direct contravention of the requirement that defective items be valued at "bona fide selling prices less direct cost of disposition." There is a similar suggestion in Loveman's testimony as to the basis actually used in valuing petitioners' second quality items. On direct *152 examination, Loveman testified as follows:
Q. Now speaking generally, if on taking your inventory you find steel in your inventory which is second quality because it contains one of these conditions you mentioned, how do you value that steel for purposes of inventory?
A. Well we figure it has a greater value than scrap in most cases, because we figure that we can process it by welding and machining and that it will have some salvagable [sic] use, and so we will put a price on it somewhere between scrap price and the prime price. [Emphasis supplied.]
It is unlikely that the term "prime price," as used by Loveman, was intended to refer to petitioners' selling prices for prime steel, since his testimony was specifically directed to petitioners' basis of valuation for inventory purposes, and petitioners never in fact valued their prime inventory by reference to the resale price therefor. Thus, the apparent thrust of Loveman's statement is that the figure of $ 3 per cwt. at which second quality items were priced represented an intermediate point between the major mill price ($ 3.90 per cwt. as of December 31, 1952) which petitioners used in pricing their first quality items and the scrap *153 price ($ 2 per cwt. as of December 31, 1952) which petitioners used in pricing other inventory *802 items. This basis of valuation, if in fact used by petitioners, in no way reflects bona fide selling prices for petitioners' second quality inventories and, consequently, would be clearly in violation of the Commissioner's regulations. Moreover, we held in the first part of our Opinion that the prevailing major mill price was itself substantially below the correct inventory value for petitioners' first quality items. The method described by Loveman of valuing second quality items merely compounds that error; it would, however, explain the gap between the inventory value of $ 3 per cwt. and the much higher prices at which petitioners' second quality items were ultimately sold.
The differential between inventory values and sales prices is even more extreme with respect to inventory items treated as scrap. For example, as pointed out in our findings, most of the items priced at $ 1 per cwt. as of December 31, 1953, were sold in 1954 and 1955 at prices generally ranging from about $ 5.50 per cwt. to $ 8.50 per cwt., and in one instance ranging as high as $ 12.09 per cwt. The lowest sales price *154 shown for a 1953 inventory item valued as scrap was for an item sold in 1954 at prices ranging from $ 3.25 per cwt. to $ 8.80 per cwt. Between December 31, 1952, and December 31, 1955, the record discloses only one sale at scrap prices even though there was a ready market for scrap during these years, and it is not even clear whether that sale represented an item previously included in closing inventory or an item subsequently acquired; most of the items valued by Loveman and Merlin as scrap for inventory purposes were sold during 1953, 1954, and 1955 at prices approximating or exceeding cost. Some items may have been sold to scrap dealers for cash without being recorded on petitioners' books in any identifiable fashion, but such sales were few, if any.
Petitioners suggest that the possibility of having to absorb processing costs was taken into account in valuing their second quality and scrap inventories. We are satisfied that petitioners did incur occasional processing costs in disposing of defective items, but the evidence and testimony regarding the amount of such costs is so vague that we have been unable to make any meaningful findings with respect thereto. Merlin could not *155 tell us the amount of those costs in any year, nor could he identify the accounts to which they were customarily charged on petitioners' books. He estimated that the cost of "planing" off-gauge material might have run as high as $ 5 to $ 6 per cwt., including freight to and from the planer, but on cross-examination he admitted that less than 10 per cent of petitioners' off-gauge steel was actually sent out for planing. Moreover, the occasional items which were planed could then be resold as first quality standard gauge items at approximately $ 10 per cwt., leaving a net sales price (gross sales price less processing *803 costs) of $ 4 or $ 5 per cwt. as compared with the value of $ 3 per cwt. accorded for inventory purposes. Defective steel other than off-gauge was processed, when necessary, in petitioners' warehouses. Merlin estimated that only about half of such additional material required processing, and that the cost of such in-warehouse operations (e.g., "cutting") ranged from a low of 25 cents per cwt. to a high of $ 2 per cwt. The little evidence there is on the point shows that such costs were actually closer to 25 cents per cwt. than to $ 2 per cwt.; and frequently they were *156 billed to customers as an addition to the selling price of the steel involved, rather than absorbed by petitioners.
Respondent submitted an exhibit consisting of a trial balance of Domestic's profit and loss accounts for the years 1951, 1952, and 1953. Other than the freight account, this balance contains only a limited number of accounts to which processing costs could have been charged; they are as follows:
| Total charge | ||
| Account | ||
| 1952 | 1953 | |
| Warehouse salaries | $ 35,486.74 | $ 32,876.52 |
| Warehouse supplies | 2,431.40 | 2,391.44 |
| Warehouse miscellaneous expense | 24.75 | 597.14 |
| 37,942.89 | 35,865.14 |
Considering that a large portion of these expenses must have been applicable to purchases and sales made during the course of the taxable year, rather than to closing inventory items, and given the indefinite nature of petitioners' case in regard to the amount of processing costs, we can only conclude that such costs were considerably less significant than petitioners would have us believe. In any event, they did not account for the substantial amount by which actual selling prices typically exceeded inventory values.
Petitioners also urge that numerous second quality and scrap items were carried in inventory for several *157 years before being liquidated, and that the unsalability of these items affected their valuation for inventory purposes. As we read the record, this is not an accurate description of the status of petitioners' inventories. While it is true that many such items were not completely disposed of for several years, they were being gradually liquidated between December 31, 1952, and December 31, 1955, at prices approximating or exceeding cost. We do not agree that petitioners at any point had large quantities of "unsalable" steel in their inventories; whatever the uncertainties existing with respect to the resale of petitioners' second quality items, they were insufficient to justify the consistently low prices at which those items were valued.
*804 Petitioners have failed completely to substantiate their valuation of inventory items classified as second quality and scrap. In our opinion, respondent's determinations (except for the inventories of December 31, 1953, and August 31, 1954), based on revaluation of the items in question at cost, more accurately reflect the resale market for petitioners' second quality and "scrap" steel during the years involved herein. Cf. American Mills Co., 2 B.T.A. 460; *158 Karges Hosiery Co., 8 B.T.A. 767; Justus & Parker Co., 13 B.T.A. 127; Cleveland Automobile Co. v. United States, 70 F. 2d 365 (C.A. 6).
As to the inventories of December 31, 1953, and August 31, 1954, a different picture is presented. It must be remembered that the great bulk of petitioners' second quality and scrap steel had been purchased by them as first quality steel in a market outside that of the major steel-producing companies. But, by the end of 1953, the latter market, with its lower prices, was again open to petitioners, which could then buy first quality steel at prices that were lower than the actual costs incurred by them in acquiring their inventories. It is for that reason that the Commissioner has abandoned his position as to revaluation of first quality steel as of December 31, 1953, and he now accepts the prices of the major steel-producing mills as of that date as a measure of the market value of the first quality inventory. His failure to make a similar concession as to petitioners' second quality and scrap steel produces the incongruous situation that the prices for first quality steel would be lower than the ones for second quality and scrap steel. We cannot *159 approve any such bizarre result. On the other hand, since such second quality and scrap steel was in fact being sold for prices that were generally higher than the applicable prices of the major steel producers for first quality steel, we must conclude that the proper inventory prices for the former cannot be less than the latter.
3. Treatment of "Freight-in" by Domestic. -- Domestic contends that because it has consistently treated its "freight-in" expenditures as a current expense it should be permitted to continue to do so. This argument is unsound, for it assumes, without justification, that the otherwise erroneous treatment of an item becomes acceptable if practiced consistently.
The pertinent regulations clearly require that "freight-in" expenditures be accounted for as part of the cost of acquiring merchandise, and not as a current expense. 3 Furthermore, the treatment *805 of "freight-in" required by the regulations is in accord with better accounting principles and more clearly reflects income than the procedure followed by Domestic. Cf. May, Stern & Co., 20 B.T.A. 241, affirmed 56 F. 2d 1034 (C.A. 3); Gus Blass Co., 18 T.C. 261, affirmed 204 F. 2d 327 (C.A. 8). As such, *160 the requirement is clearly within the Commissioner's authority under section 22(c), I.R.C. 1939, to prescribe inventory methods which conform "as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income."
As indicated by our findings, the record does not provide a satisfactory basis for determining with any exactitude the amount of "freight-in" applicable to Domestic's inventories as of December 31, 1952, and December 31, 1953. Respondent's agent was able to determine the precise amount of "freight-in" applicable to Domestic's inventory as of December 31, 1951. Absent sufficient records to make a similar determination for 1952 and 1953, the agent computed *161 the ratio that the "freight-in" applicable to Domestic's 1951 inventory bore to the cost of that inventory, exclusive of "freight-in"; he then applied the percentage thus derived to the cost, exclusive of "freight-in," of Domestic's closing inventories for 1952 and 1953. In the circumstances, we think that the procedure followed by the agent was reasonable, but our own computations, which are based on stipulated figures, indicate an apparent error in the agent's arithmetic. He computed the aforementioned ratio to be approximately 10 per cent whereas our computations indicate a ratio of 8 per cent. The figure of 8 per cent also appears to be more in line with the result achieved by applying the prevailing truck rates to the total weight of Domestic's closing inventories in 1952 and 1953. Consequently, we think that applicable "freight-in" for 1952 and 1953 should be recomputed by applying the ratio of 8 per cent to the cost of Domestic's closing inventories, exclusive of "freight-in," in those years.
4. Deductibility of "Interest" Accrued by Export. -- Export admits that prior to the summer of 1954, it was not subject to any obligation to pay interest on its indebtedness to Domestic, *162 nor was there any agreement at the time such indebtedness was incurred that interest would be charged at some future date. According to Loveman's testimony, the decision to charge interest to Export was reached at some unspecified time during the summer of 1954 at a "general discussion that we had between the stockholders, maybe over lunch or something like that, and maybe one of the attorneys there." Although the amounts subsequently entered upon Export's books as interest owing to Domestic were accrued only with respect to the monthly balances of indebtedness during 1954, and not with respect to similar balances in any previous year, we think the general *806 rule -- that interest may not be accrued where there is no obligation to pay interest -- nevertheless applies.
In Howell Turpentine Co., 6 T.C. 364, reversed on another issue 162 F. 2d 316 (C.A. 5), the taxpayer, over a period of 9 years, had borrowed money on open account from the corporation of which he was the principal stockholder. Prior to December 1940, the taxpayer was not subject to any obligation to pay interest to the corporation, nor did he in fact pay any interest. On December 26, 1940, he repaid the principal of his *163 loans, plus an additional amount allegedly representing interest at 6 per cent computed on the average yearly balances owing to the corporation during the aforementioned 9-year period, which included the taxable year in question. We held that respondent correctly disallowed the taxpayer's deduction -- not only for interest accrued with respect to prior years, but also with respect to 1940, because there was no obligation to pay interest at any time prior to December 1940. The same result follows from the facts of the instant case. Cf. A. Backus, Jr., & Sons, 6 B.T.A. 590; Rainbow Gasoline Corporation, 31 B.T.A. 1050. Accordingly, we sustain respondent's disallowance of the interest deduction claimed by Export on its return for the fiscal year ended August 31, 1954.
5. Cost of Paving Perkins Road. -- During its fiscal year ended August 31, 1953, Export contributed $ 8,279.29 toward the cost of paving Perkins Road, a dead end street adjoining its warehouse premises. On its return for the fiscal year ended August 31, 1953, Export claimed a depreciation deduction with respect to its expenditure, based on a 20-year useful life for the road. Respondent disallowed this deduction. In *164 its petition, Export alleged that the entire amount of its contribution toward paving was deductible in fiscal 1953 as an ordinary and necessary business expense. On brief, and in the alternative, Export argues that the amount in question, if not entirely deductible in the year incurred, was depreciable over a 15-year period rather than the 20-year period estimated on its tax return.
We think that Export's original treatment of its paving expenditure, as a capital outlay depreciable over a 20-year period was correct. It is well established that such expenditures are capital in nature rather than ordinary and necessary business expenses. L. Z. Dickey Grocery Co., 1 B.T.A. 108; E. W. Edwards & Sons, 3 B.T.A. 889; E. W. Edwards and Son v. Clark, 29 F. Supp. 671; Lord & Bushnell Co., 7 B.T.A. 86; Wood v. Commissioner, 245 F. 2d 888 (C.A. 5), affirming on this issue T.C. Memo. 1955-301; Algernon Blair, Inc., 29 T.C. 1205; Frank B. Cooper, 31 T.C. 1155. As a capital expenditure, the cost of paving Perkins Road is depreciable if the road constitutes "property used in the trade or business" of *807 Export. Sec. 23(l), I.R.C. 1939. In our opinion, Perkins Road meets that statutory requirement. *165 It adjoined Export's warehouse premises, and those premises would have been inaccessible by truck but for such paving. In short, the road was a necessary and integral part of Export's general warehouse operation.
Respondent's only argument in opposition to this conclusion is that at the time Export acquired its warehouse premises the fee title to Perkins Road was probably vested in the local municipality under Ohio statutes. The record is quite vague with respect to who had title to the road. But assuming, without deciding, that fee title was vested in the local municipality, we fail to see how that affects our conclusion. The paving was not undertaken to improve the fee. It was required as an essential adjunct to Export's warehouse facilities, and the road was undoubtedly used in Export's trade or business. In E. W. Edwards & Sons, 3 B.T.A. 889, the taxpayer constructed tunnels under public streets in Rochester, New York, in order to connect various department store buildings which it operated. The construction of the tunnels was authorized by municipal ordinances and licenses. We held, as follows, at page 891:
The taxpayer's tunnels were constructed under municipal ordinances, *166 and so long as such ordinances remain unrepealed, the right to use such tunnels and the cost of their construction must be presumed to have a continuing capital value to the taxpayer's business. The cost of constructing such tunnels should be treated as a capital expenditure, subject to an allowance for exhaustion of the construction cost.
The case of Algernon Blair, Inc., 29 T.C. 1205, cited by respondent, is not in point. In that case, we found that the improvements in question had been turned over by the taxpayer to the local government; that the local government maintained the improvements; that the streets and roads involved had been incorporated into the municipal and county road systems, and were used "primarily in the public business" rather than in the taxpayer's business. In the instant case, we have found that the local government refused to pave Perkins Road when requested to do so by the interested property owners. In fact, the village officials suggested that the property owners pave the road themselves. Although Perkins Road was open to public use, it was not used "primarily in the public business"; it was a dead end street adjoining Export's warehouse and was used *167 primarily in Export's business and the businesses of others who contributed toward the paving.
The issue with respect to whether the useful life of the road was 15 or 20 years was not raised by the pleadings and is not properly before us. Erwin Gerber, 32 T.C. 1199. In any event, Export has *808 not shown that respondent erred in failing to allow a useful life shorter than 20 years.
Decisions will be entered under Rule 50.
Footnotes
1. Exclusive of 39,045 pounds sold as scrap at $ 1.79 per cwt.
1. This sale was identified as having been made out of a purchase in the same month (April 1953) of 950,000 pounds at a cost of $ 4 per cwt.↩
1. It is not clear why these items were considered "unsalable," since the record shows that Domestic in fact disposed of almost all these items in 1954 and 1955 at prices substantially higher than $ 3 per cwt. and, in many instances, at prices exceeding the cost of these items.↩
1. It is not clear why this item was marked "unsalable," since Domestic in fact sold substantial quantities of it in 1954 and 1955 at prices varying between $ 3.75 and $ 6 per cwt.↩
1. Regs. 111, sec. 29.22(c)-2; Regs. 118, sec. 39.22(c)-2, both of which state as follows:
Valuation of Inventories. -- Section 22(c) provides two tests to which each inventory must conform:
(1) It must conform as nearly as may be to the best accounting practice in the trade or business, and
(2) It must clearly reflect the income.
It follows, therefore, that inventory rules cannot be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order clearly to reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used is substantially in accord with these regulations. An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income.↩
2. It does not clearly appear that "overruns" were in general physically distinguishable from steel acquired as first quality, or that petitioners did not in fact resell such merchandise in the same manner as steel acquired as first quality.↩
3. Regs. 111, sec. 29.22(c)-3, and Regs. 118, sec. 39.22(c)-3(b), provide in part that "cost" as it applies to inventories means "the invoice price less trade or other discounts, except strictly cash discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this net invoice price should be added transportation or other necessary charges incurred in acquiring possession of the goods."↩