*3720 1. For the year 1920, petitioner is permitted at the close of the year to change the basis of taking inventory from cost, to cost or market, whichever is lower, as authorized by article 1582 of Regulations 45, which article is authorized by section 203 of the Revenue Act of 1918.
2. Money used by petitioner held to be borrowed money, and not paid-in surplus, for invested-capital purposes.
*812 This is a proceeding for the redetermination of a deficiency in income and excess-profits tax for the fiscal year ended August 31, 1920, in the amount of $1,737.78.
Petitioner assigned four errors on the part of the Commissioner, as follows:
*813 (1) The Commissioner erred in disallowing a reduction of petitioner's closing inventory from cost, to cost or market, whichever is lower.
(2) The Commissioner erred in disallowing "as invested capital $2,103.82, representing the pro rata amount of $5,000 each, paid-in surplus, paid to the company on May 30 and June 30, 1920, respectively, on the theory that it represented borrowed money."
(3) The*3721 Commissioner erred in computing depreciation on furniture and fixtures on book values thereof, that is, depreciated cost, rather than on cost "as at January 1, 1920."
(4) The Commissioner erred in reducing invested capital in the amount of $218.22, representing income tax for the year ended August 31, 1919, prorated.
FINDINGS OF FACT.
The petitioner is a Texas corporation with its principal office in Galveston. Its business is retail merchandising.
In the years prior to 1920, it was the custom of the petitioner to take inventory at the close of each fiscal year on the cost basis. Following that custom and because it was not known by its officers that an inventory could legally be taken on any other basis, it took inventory as of August 31, 1920, on the cost basis. That inventory totaled approximately $72,000.
About October 10, 1020, and before its income-tax returns were made, it was informed that it had the right to make its inventory on the cost, or cost or market, whichever is lower, basis. Following that advice, the officers of petitioner who were posted on market prices of the kind of merchandise carried in stock by petitioner, undertook to adjust the inventory*3722 to a basis of cost or market, whichever was lower. In doing this they made a thorough investigation by an examination of the invoices they had received of merchandise purchased within the last past six months; also of price lists obtained from jobbers. They found that the prices indicated by such data as they so used varied greatly. In fact the market on several articles of merchandise such as silk skirts was in a chaotic condition. However they considered all such data and averaged the various prices of each article, and as the result of such adjustment found that market on August 31, 1920, was lower than cost of merchandise on hand of ten articles to the extent of the following per cent off:
| Silk shirts | 30 per cent |
| Cotton shirts | 10 per cent |
| Pajamas | 10 per cent |
| Underwear | 10 per cent |
| Belts | 10 per cent |
| Women's hosiery | 25 per cent |
| Boys' hosiery | 10 per cent |
| Boys' neckwear | 25 per cent |
*814 The total cost of the merchandise affected by that readjustment was $26,076.01, and the total reduction made was $4,060.71.
On May 1, 1920, $5,000 was borrowed from J. E. Pearce, and on June 1, 1920, $5,000 was borrowed from J. E. Pearce. The petitioner*3723 claims the money was borrowed by Ben C. Doherty and paid in to the company as paid-in surplus; the respondent urges it was a loan to the company. The record of those transactions on the books of the company is substantially as follows: "1920, Loan note - J. E. Pearce - $5,000." That amount is posted on the credit side of the general ledger to surplus account under date of May 31, from J. E. Pearce, $5,000. Under date of June, 1, in the cash book appears "loan, J. E. Pearce - $5,000." That is posted under date of June 30, to surplus account in the general ledger. In February, 1923, occurred the next entry. At that time treasury stock was charged $10,000, deficit in surplus account credited $10,000, with notation "stock returned to the company by shareholders for resale to clear out deficit." In March, 1923, the journal shows surplus account is charged with $10,000 paid-in surplus returned to Ben C. Doherty. Another journal entry of the same date is in effect that Ben C. Doherty is credited with $10,000, notes payable to J. E. Pearce, and an explanatory notation is "company's note issued to J. E. Pearce, assuming and in payment of the note of Ben C. Doherty."
Petitioner had no*3724 record of cost of furniture and fixtures, the books containing that record having been lost. In order to determine that data the accountant who made out the return referred to the return made for the prior year and found that depreciation had been taken in the amount of $561.31, and the ledger showed furniture and fixtures account charged, after deducting that amount of depreciation, with $3,000. The accountant therefore concluded that the original account showed a cost of $3,561.31. That account, however, included cost of an automobile, $420, leaving cost of furniture and fixtures $3,141.31, upon which petitioner took depreciation for the year in question. The Commissioner used the amount shown in the furniture and fixtures account in the ledger, $3,000, and deducting cost of automobile, obtained $2,580 upon which he allowed depreciation.
The Commissioner determined the income tax for the 1919 fiscal year at $517.76, and prorated the same over 1920, thereby reducing invested capital. It was conceded by counsel for the respondent, at the hearing, that the correct amount of that tax was $448.65 instead of $517.76.
OPINION.
LOVE: The first issue to be discussed is whether*3725 or not petitioner, for the fiscal year ended August 31, 1920, had the legal right to *815 revise its inventory made at the close of that year from a cost basis, which had been the basis used in prior inventories, to a basis of cost or market, whichever was lower.
The facts are that the inventory on the cost basis showed an aggregate value, approximately, of $72,000. With reference to the ten items of merchandise in that inventory, petitioner's manager knew that market prices had materially declined during the year and since the purchase of those articles. At the time of taking that inventory, the manager did not know that it could be, legally, taken on any other basis than cost. He thereafter was informed that he was permitted to take it on a cost or market basis. He then revised said inventory. The prices on those ten articles as asked by the various jobbers were not uniform, but varied materially. Petitioner's manager had a number of such price lists, together with invoices of goods purchased within the past six months. These prices were averaged and he used such average as market, and reduced cost to conform to such market prices.
Did he have a legal right to*3726 pursue that course? The rule generally adhered to by this Board and the courts, and insisted on by the Commissioner, is that a uniform method of taking inventory from year to year must be adhered to. Section 203 of the Revenue Act of 1918 says:
That whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer 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.
Article 1582 of the Commissioner's Regulations 45, promulgated under the Act above quoted, prescribes certain rules relative to valuation of inventories, one clause of which is pertinent to the issue here involved, and is:
A taxpayer may, regardless of his past practice, adopt the basis of "cost or market whichever is lower", for his 1920 inventory, provided a disclosure of the fact and that it represents a change is made in the return.
It seems clear that for the year 1920 the petitioner had a legal right to change from its accustomed*3727 basis of cost to cost or market, whichever was lower. While reductions were made in only ten articles, other articles were considered, and if any other articles could have been, and were not, reduced, the petitioner and not the respondent was the loser. On this issue the action of the Commissioner is overruled. See ; ; .
*816 In regard to the issue raised by the second assignment of error, it may be here pointed out that the burden of proof is on the petitioner to establish the fact that the $10,000 borrowed from Pearce was not borrowed by the corporation, but by a stockholder, individually, and by him paid in to surplus.
The books of petitioner indicate that it was carried as a loan. There is no evidence as to whether the corporation or Doherty paid the interest to Pearce. In 1923 the corporation formally assumed the payment of the notes to Pearce and Doherty was given credit for the $10,000. If this was not a loan from Pearce to the corporation the evidence is very persuasive that it was a loan from Doherty*3728 to the corporation. On this issue the action of the Commissioner is approved.
With reference to depreciation on furniture and fixtures involved in the third assignment of error, petitioner seeks to establish cost by a reference to its return for 1919, and having learned therefrom that depreciation was taken in the amount of $561.31, that amount was deducted, leaving $3,000 which was set up on the books as a charge against furniture and fixtures account. If we should disregard the ambiguous nature of the method used in arriving at that charge of $3,000, and concede that $3,000 was actually arrived at, at the close of 1919, as the accountant concluded that it was, still the proof of the cost of furniture and fixtures is not of the character required to overcome the presumption of the correctness of the determination of the Commissioner. On this issue the action of the Commissioner is approved.
On the fourth issue it was conceded by the respondent that the amount of tax computed for 1919 and prorated and used to decrease invested capital for 1920, was $448.65 instead of $517.76. With that correction made, the action of the Commissioner on that issue is sustained. Section 1207*3729 of the Revenue Act of 1926. .
Judgment will be entered on 15 days' notice, under Rule 50.