*78 Decision will be entered under Rule 50.
1. The Commissioner sought to recompute petitioner's income for the short taxable period Dec. 22 to 31, 1961, which was closed by the statute of limitations. Held, such recomputation is permissible for purposes of determining the amount of a 1964 net operating loss carryback absorbed in that short taxable period, in order to compute the remaining amount of that carryback that would be available to petitioner in a subsequent (1962) open year.
2. Petitioner, an accrual basis taxpayer was engaged in the business of recording and distributing phonograph records. Evans, a minor, was one of its recording artists. In 1962 petitioner entered into a letter agreement with the guardian of Evans' estate, whereby petitioner undertook to make monthly payments to Evans totaling $ 450,000 over a 5-year period. Petitioner also agreed that if royalties, to be computed on the basis of records "paid for and not subject to return," exceeded $ 450,000, it would pay such excess to Evans beginning on Mar. 1, 1967. The agreement was subsequently amended to increase the aggregate amount of the monthly cash payments to $ 575,000. Held, petitioner's liability*79 for royalties in excess of the monthly cash payments was not sufficiently fixed or determinable to permit accrual during the short taxable period Dec. 22 to 31, 1961, and in the calendar years 1962 and 1963.
*1083 The Commissioner determined deficiencies of $ 71,270.15 and $ 146,041.46 in the income tax of Cameo-Parkway Records, Inc., for the calendar years 1962 and 1963, respectively. By an amendment to answer the Commissioner claimed an increased deficiency for 1963 of $ 244,265.09. The issues presented for decision are as follows: (1) Whether the Commissioner may increase petitioner's 1962 deficiency on the basis of his recomputation of petitioner's taxable income for a prior period which was closed by the statute of limitations, and (2) whether petitioner, an accrual basis taxpayer, may deduct in 1962 and 1963 certain royalty expenses accrued on its books during such years with respect to its sales of phonograph records.
FINDING OF FACT
The parties have filed*81 a stipulation of facts which, together with the attached exhibits, is incorporated herein by this reference. 1
*1084 Petitioner ABKCO Industries, Inc., formerly known as Cameo-Parkway Records, Inc., was organized under the laws of the State of Delaware on December 20, 1961. Through a statutory merger on December 21, 1961, it succeeded to the business of Bernard Lowe Enterprises, Inc., and Parkway Records, Inc. In February 1969, in accordance with the provisions of the General Corporation Law of the State of Delaware, the name of petitioner was changed from "Cameo-Parkway Records, Inc." to "ABKCO*82 Industries, Inc."
Petitioner was an accrual basis taxpayer. It filed its Federal corporate income tax returns for the short taxable period December 22, 1961, to December 31, 1961, and for the calendar years 1962 through 1964 with the district director of internal revenue at Philadelphia, Pa. At the time the petition in this case was filed, petitioner's principal office was located at 309 South Broad Street, Philadelphia, Pa.
During the years here in issue petitioner was engaged in the business of recording and distributing at wholesale phonograph records containing vocal and orchestral performances by a number of popular artists. Petitioner was a member of a highly competitive industry. Its success was dependent upon the public's taste in popular music, and there was no assurance that its current recording artists would continue in vogue.
Ernest Evans (Evans), known in the entertainment field as Chubby Checker, was one of a number of recording artists with whom petitioner had recording contracts during the years here in issue. Evans had been a recording artist for petitioner's predecessors, and as a result of the merger of December 21, 1961, petitioner assumed the obligation *83 to pay Evans royalties in accordance with prior agreements. Evans was then a minor. On February 15, 1962, a letter agreement dated December 29, 1961, between petitioner and Merton J. Matz, the court-appointed "Guardian for the Estate of Ernest Evans, a minor," was executed by Bernard Lowe on behalf of petitioner and by Matz. The letter agreement, addressed by petitioner to Matz, provided that it would be in effect for 5 years, commencing on December 29, 1961. Under the agreement, Evans (identified therein as "Artist") was required to record a minimum of eight record sides during each calendar year while the contract was in effect:
3. Recordings will be made by Artist at recording sessions in our studios or studios designated by us, at mutually convenient times. A minimum of eight (8) record sides shall be recorded during each calendar year of this contract, and additional record sides shall be recorded at our election. The musical compositions to be recorded hereunder shall be mutually agreed upon between Artist and us, and each recording shall be subject to our approval as satisfactory for manufacture and sale. Upon our request Artist shall rerecord each selection until a commercially*84 satisfactory recording shall be obtained. All recordings hereunder are to be released under such record label as we may elect.
*1085 The letter agreement provided that petitioner would make two types of payments to Evans. Under paragraph 5 petitioner agreed to make payments of $ 7,500 per month for the duration of the contract:
5. For the rights herein granted and services to be rendered during the term of this agreement, we shall pay the following compensation so long as Artist is performing his obligations under this agreement as of each payment date:
$ 90,000.00 per annum, at the rate of $ 7,500.00 per month, on the 28th day of each month, commencing January 28, 1962 and ending December 28, 1966, making a total of $ 450,000.00.
The aforesaid payments shall be paid regardless of whether or not royalties computed under Paragraph 6 hereof equal such payments as of said payment dates. No portion thereof shall be refundable to us. After October 3, 1962, when Artist shall attain age twenty-one (21), payments shall be made directly to him.
In paragraph 6 petitioner undertook to pay royalties to Evans in excess of the $ 450,000 payable under paragraph 5:
6. In the event*85 that Artist shall have fulfilled all his obligations under this Agreement until December 28, 1966, the expiration date hereof, and in the event that the royalties, as hereinafter computed for the entire term of this agreement [including royalties pursuant to Prior Agreements as per sub-paragraph (f) hereof], exceed the total of $ 450,000.00 paid as aforesaid, we shall pay to Artist on March 1, 1967, as additional compensation, such excess; otherwise no royalties shall be payable. However, in the event that royalties computable after December 28, 1966, when added to the said total as of December 28, 1966, exceed $ 450,000.00, then the excess shall be payable to Artist on each subsequent accounting, as provided in Paragraph 7 hereof. Said royalties shall be computed as follows:
(a) A royalty of five percent (5%) of the suggested retail list price per record (exclusive of all sales and excise taxes and duties, and less costs of containers and packaging not exceeding 50 cents per container or package), for ninety percent (90%) of all double-faced records manufactured hereunder and sold by us in the United States and paid for and not subject to return, on both faces of which are embodied*86 any of the selections recorded hereunder, and one-half (1/2) of such royalty for ninety percent (90%) of all double-faced records manufactured hereunder and sold by us in all other countries and paid for, and not subject to return, on both faces of which are embodied any of the selections recorded hereunder; and one-half (1/2) of the respective amounts of such royalty for ninety percent (90%) of all records manufactured and sold by us on only one face of which is embodied a selection recorded hereunder. * * *
(b) We will pay for the services of accompanying musicians, arrangers, copyists and vocalists at the rates of union scale, including contributions for Pension and Welfare funds, and such payments shall be charged against Artist's royalties provided however, that we will make only one such charge for each side released.
* * * *
(d) No royalties shall be payable on any professional copies or free records given or sent for sales promotion purposes, it being further understood, however, that such professional copies and free records, except as hereinafter provided in sub-paragraph (e), shall not exceed ten percent (10%) in quantity of *1086 the records manufactured and sold*87 by us and upon ninety percent (90%) of which you receive the agreed royalties.
(e) With respect to records sold through any plan or device commonly referred to in the trade as a "record club," the royalties payable shall be equal to one-half (1/2) of the royalty otherwise payable hereunder, provided, however, that no royalty shall be payable with respect to records which are distributed to members of such record club either as a result of joining the club or as the result of the purchase of the required number of records, including records distributed as "bonus" and/or "free" records. However, such bonus or free records shall not exceed the number of records that are sold by the record club upon which royalties are paid by us pursuant hereto.
(f) Any royalties due under said Prior Agreements dated April 6, 1960 and April 27, 1961, for records released prior to the term of this agreement, shall be added to and calculated as part of the total royalties to be computed for the entire term of this agreement under Paragraph 6 hereof. No other payment shall be made upon said royalties other than as provided in Paragraph 6 hereof.
Petitioner was required to make a semiannual accounting*88 with respect to the royalties described under paragraph 6 and, beginning March 1, 1967, make payments of amounts due thereunder as follows:
7. An accounting with respect to royalties computed pursuant to Paragraph 6 hereof shall be made by us to you and/or Artist semiannually on the 1st day of May for records sold and paid for during the period ending the preceding February 28, and on the 1st day of November for the period ending the preceding August 31st in each year, and on March 1, 1967, for the period ending December 28, 1996. Similar accountings shall be made semi-annually after the expiration of the term of this agreement. The accounting on March 1, 1967, and the accountings thereafter shall be accompanied by payment of accrued royalties earned by Artist in excess of the $ 450,000.00 paid as set forth in Paragraph 5 hereof. All royalty statements and all other accounts rendered by us to you and/or Artist shall be binding upon the Artist and you, and not subject to objection for any reason unless specific objection in writing, stating the basis thereof, is given to us within one (1) year from the date rendered. However, we shall have the right to take from the amount of royalties*89 due any advance royalties previously paid.
Upon reaching the age of 21 on October 3, 1962, Evans affirmed the letter agreement.
On November 23, 1962, Evans and petitioner executed an instrument (Supplemental Agreement) amending the original letter agreement (Principal Agreement). Under the Supplemental Agreement, paragraph 5 of the Principal Agreement was amended to increase the total amount to be paid under that provision from $ 450,000 to $ 575,000 as follows:
1. Paragraph 5 of Principal Agreement is hereby amended to read as follows:
"For the rights herein granted and services to be rendered during the term of this Agreement, we shall pay the following compensation so long as Artist is performing his obligations under this Agreement as of each payment date: $ 95,000.00 for the annual period commencing on the date hereof *1087 and ending on December 28, 1962 in ten (10) consecutive monthly payments of $ 7,500.00 each commencing on January 28, 1962 and two (2) monthly payments of $ 10,000.00 each payable on November 28, 1962 and December 28, 1962 and thereafter for the balance of the term of this Agreement $ 120,000.00 per annum payable at the rate of $ 10,000.00 per month*90 commencing on November 28, 1962 for a period of forty-eight (48) consecutive months making a total of $ 575,000.00.
* * * *
2. The amount of "$ 450,000.00" which appears in lines 6 and 11 of paragraph 6 and line 11 of paragraph 7 of Principal Agreement is hereby in each such three instances amended to read "$ 575,000.00".
In addition, petitioner was granted an option to extend the term of the Principal Agreement from December 28, 1966, until December 28, 1967, by giving Evans written notice of its intention to do so on or before September 28, 1966. The agreement provided that if the option were exercised, petitioner (identified therein as "CAMEO") would make payments to Evans as follows:
CAMEO shall pay to EVANS the sum of $ 120,000.00 payable in twelve (12) equal consecutive monthly payments of $ 10,000.00 each, the first of which is to be paid on January 28, 1967 plus the amount, if any, by which royalties computed for the additional one (1) year period of the contract in accordance with the provisions of paragraph 6(a), 6(b), 6(c), 6(d) and 6(e) of Principal Agreement exceeds $ 120,000.00, such excess amount, if any, to be paid by CAMEO to EVANS on or before March 28, 1967.
*91 Petitioner accrued on its books, on the basis of records shipped to wholesale distributors, the following amounts pertaining to records on which Evans was the artist:
| Year ended | Amount |
| Period to Dec. 31, 1961 | $ 17,973.64 |
| Dec. 31, 1962 | 433,712.00 |
| Dec. 31, 1963 | 187,065.00 |
| Dec. 31, 1964 | None |
The foregoing amounts were claimed as deductions as part of "Cost of goods sold" on petitioner's Federal corporate income tax returns for the periods indicated above.
For the year ended December 31, 1964, petitioner included in income $ 31,459.95 stemming from Evans' records returned to it in excess of Evans' records shipped, and with respect to which royalties had been accrued in prior years.
For the short period January 1, 1965, to June 30, 1965, petitioner accrued $ 95,267 on the basis of Evans' records which were shipped to wholesale distributors. In the same period petitioner paid Evans $ 61,144.
*1088 For the fiscal year ended June 30, 1966, petitioner paid royalties to Evans in the amount of $ 122,683. Petitioner did not accrue on its books for that year any amounts pertaining to records shipped to wholesale distributors on which Evans was the artist. However, petitioner*92 did include in income $ 82,653 for royalties accrued on its books in prior periods with respect to records which had been returned and on which Evans was the artist.
On or about June 15, 1962, petitioner filed its Federal corporate income tax return for the short taxable period beginning on December 22, 1961, and ending on December 31, 1961. On or about July 6, 1965, petitioner received a refund of $ 14,980.60 for such taxable period as a result of timely filing, under the provisions of section 6411, I.R.C. 1954, an application for a tentative carryback adjustment. The adjustment offset reported taxable income of $ 39,385.76 by a deduction arising out of a net operating loss in the amount of $ 823,984.60 incurred in the taxable year ending December 31, 1964.
On or about June 6, 1967, the Commissioner mailed to petitioner a statutory notice of deficiency. In it he disallowed the $ 17,973.64 deduction claimed by petitioner on its return for the short taxable period December 22, to December 31, 1961, with respect to its agreement with Matz and Evans. The effect of that determination was to increase from $ 39,385.76 to $ 57,359.40 the amount of petitioner's 1964 net operating loss*93 carryback absorbed in reducing its taxable income for the short 1961 period to zero. The Commissioner determined that as a result only $ 766,625.20 of such carryback remained available as a deduction from petitioner's income in 1962 and that its taxable income for that year must be increased accordingly. In the same deficiency notice the Commissioner also determined that petitioner was entitled to deduct royalty expenses in respect of its agreement with Matz and Evans only to the extent of $ 95,000 for the calendar year ended December 31, 1962, and $ 120,000 for the calendar year ended December 31, 1963 -- the amounts payable under paragraph 5 of the agreement during those years. Thus, after conceding an error in the deficiency notice, the Commissioner's position is that petitioner is not entitled to the claimed royalty expense deductions to the extent of $ 338,712 and $ 67,065 in 1962 and 1963, respectively.
OPINION
1. The first issue for decision is whether in determining the deficiency in petitioner's 1962 income tax, the Commissioner is entitled to disallow the deduction petitioner claimed on its return for the short taxable period December 22 to December 31, 1961, and thereby*94 reduce the portion of the 1964 net operating loss carryback *1089 available to it in computing its 1962 income tax. Petitioner contends that the statute of limitations has run on the 1961 period and that the Commissioner may not recompute income for a barred period in order to determine the proper net operating loss carryback deduction in an open year. Petitioner urges that by making such recomputation, the Commissioner is attempting to do indirectly what the statute of limitations prohibits him from doing directly.
The Commissioner does not dispute that the 1961 period is closed by the statute of limitations. See sec. 6501(a), I.R.C. 1954. He simply points out that he has not determined a deficiency for that period, that he has recomputed petitioner's short period income only for the purpose of determining its income tax liability for 1962, and that the statute of limitations is not a bar to such recomputation. We agree. The Commissioner's position finds support in section 6214(b), I.R.C. 1954, 2*96 and in a substantial body of case law. See, e.g., Dynamics Corp. v. United States, 392 F. 2d 241, 249 (Ct. Cl.); Phoenix Coal Co. v. Commissioner, 231 F. 2d 420, 421-422*95 (C.A. 2), affirming a Memorandum Opinion of this Court; State Farming Co., 40 T.C. 774, 781-783; 3 cf. Anthony Mennuto, 56 T.C. 910. Edward G. Leuthesser, 18 T.C. 1112; Ione P. Bouchey, 19 T.C. 1078; and Bunn's Auto Sales, Inc., 35 T.C. 861, relied upon by petitioner, involved deficiency determinations with respect to years which were barred by the statute of limitations. That is not the case here. See Phoenix Coal Co. v. Commissioner, 231 F. 2d at 422. We have considered petitioner's efforts to distinguish Phoenix Coal Co., supra, and to have it overruled. We found them entirely unconvincing, and we uphold the Commissioner's position. 4
2. The second and principal issue for decision is whether, in the short taxable period December 22 to 31, 1961, and in the calendar years 1962 and 1963, petitioner may accrue royalties computed but not yet paid under paragraph 6 of its agreement with Matz and Evans. Section *1090 446, I.R.C. 1954, 5 authorizes the use of *97 an accrual method of accounting, and the Commissioner has not questioned petitioner's status as an accrual method taxpayer. Section 461 (a), I.R.C. 1954, provides that "The amount of any deduction * * * allowed by this subtitle shall be taken for the taxable year which is the proper taxable year under the method of accounting used in computing taxable income." Regulations section 1.461-1 (a) (2) sets forth the general rule for determining the proper year for deduction by an accrual method taxpayer:
Under an accrual method of accounting, an expense is deductible for the taxable year in which all the events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy. * * * While no accrual shall be made in any case in which all of the events have not occurred which fix the liability, the fact that the exact amount of the liability which has been incurred cannot be determined will not prevent the accrual within the taxable year of such part thereof as can be computed with reasonable accuracy.
See also Security Flour Mills Co., 321 U.S. 281, 284; Dixie Pine Products Co. v. Commissioner, 320 U.S. 516, 518-519;*98 Lucas v. American Code Co., 280 U.S. 445, 449-451; American National Co. v. United States, 274 U.S. 99, 104-105; United States v. Anderson, 269 U.S. 422, 440-441.
*99 The issue between the parties is thus whether petitioner's liability for royalties under paragraph 6 was sufficiently fixed or determinable to permit accrual during the periods here in question. We conclude that petitioner's liability for such royalties was so contingent and uncertain that accrual is impermissible and that the Commissioner's determination must therefore be sustained.
Under the agreement as originally executed in 1961, petitioner was not required to make any royalty payments at all (in excess of the monthly cash payments under paragraph 5) unless the royalties computed under paragraph 6 exceeded $ 450,000. During the short 1961 period and the 1962 calendar year petitioner accrued on its books a total of $ 451,685.64 as royalties under the agreement. However, in *1091 November of 1962, the agreement was amended so that the $ 450,000 minimum amount was increased to $ 575,000. Thus, as of the end of 1962 it remained uncertain whether petitioner would ever be liable for any payments whatever under paragraph 6; royalties computed under paragraph 6 were still approximately $ 123,000 below the minimum amount which had to be reached before any payments were required*100 under that paragraph.
On its books for 1963 petitioner accrued $ 187,065 with respect to the Evans contract. Thus, by the end of 1963, petitioner had accrued royalties which exceeded the $ 575,000 minimum amount by approximately $ 64,000. However, petitioner's accruals were made on the basis of records shipped to wholesale distributors. The formula under paragraph 6, on the other hand, provided for royalties to be computed on the basis of records "paid for and not subject to return." As a result, to the extent that records shipped might not be paid for or might subsequently be returned, petitioner's accruals overstated its liability under paragraph 6. Petitioner and Evans were involved in a highly competitive industry. Sale of Evans' records were dependent upon the public's taste in popular music and there was no assurance that his popularity would continue. Petitioner has not shown that as of 1963, it was unreasonable to expect a significant number of records to be unpaid for or to be returned. Indeed, in its return for the calendar year ending December 31, 1964, petitioner included over $ 31,000 in income with respect to returns of Evans' records; and on its income tax*101 return for the taxable year ending June 30, 1966, petitioner included in income $ 82,653 with respect to returns of Evans' records. By March 1, 1967, the time when the first paragraph 6 royalties were to be paid, the figure computed under paragraph 6 might well have been below the minimum amount of $ 575,000. Thus, as of the end of 1963, it was not clear that petitioner would ever be liable for any payments under paragraph 6. In such circumstances, accrual of royalties described by paragraph 6 was improper. Cf. Dixie Pine Products Co. v. Commissioner, 320 U.S. 516, 519; Lucas v. American Code Co., 280 U.S. 445, 452.
Petitioner has relied heavily upon Helvering v. Russian Finance & Construction Corp., 77 F. 2d 324 (C.A. 2), and Ohmer Register Co. v. Commissioner, 131 F. 2d 682 (C.A. 6). Both cases are distinguishable on the basis of one fundamental point. In Russian Finance & Construction Corp., 77 F. 2d at 327, the Second Circuit emphasized that the expense there in issue was "absolute and fixed, in that no*102 further event was needed to occur to bring it into existence." Similarly, in Ohmer Register Co., 131 F. 2d at 686, the Court pointed out that "the right to deduct an expense item accrues when the fixed obligation is *1092 incurred, even though the amount may be diminished by subsequent events." 6 Here, on the other hand, petitioner has failed to show that it had incurred a fixed obligation under paragraph 6 during the taxable periods in question. No payments were required under that paragraph until royalties, computed on the basis of records "paid for and not subject to return," reached $ 575,000, and petitioner has failed to show that such minimum figure was reached during the taxable periods here in issue. We sustain the Commissioner's determination.
*103 Decision will be entered under Rule 50.
Footnotes
1. The parties have stipulated various facts, particularly as to losses in later years, which will have an impact, by the way of carrybacks, upon the amount of tax to be determined under Rule 50, but which are not relevant to the issues to be decided herein. Accordingly, they are not set forth above, but, having been incorporated in the Findings by reference, they will be taken into account in the Rule 50 computations.↩
2. SEC. 6214. DETERMINATIONS BY TAX COURT.
(b) Jurisdiction Over Other Years. -- The Tax Court in redetermining a deficiency of income tax for any taxable year or of gift tax for any calendar year shall consider such facts with relation to the taxes for other years as may be necessary correctly to redetermine the amount of such deficiency, but in so doing shall have no jurisdiction to determine whether or not the tax for any other year has been overpaid or underpaid.↩
3. See also Morton Q. Petersen, T.C. Memo. 1971-21, and cases cited therein; Pacific Transport Co., 29 T.C.M. 133↩, 161-162, P-H Memo. 70-154, 70-186 -- 70-187, on appeal (C.A. 9).
4. Petitioner has also argued that the Commissioner's disallowance of the $ 17,973.64 royalty deduction was unjustified on the ground that the Principal Agreement was not executed until Feb. 15, 1962, and did not affect the accrual of royalties in 1961 under the prior agreement. However, the prior agreement was not introduced in evidence. In light of the fact that the burden of proof is upon the petitioner, we cannot simply assume that its liability under such agreement was any more certain than it was under the 1962 instrument.↩
5. SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING. (a) General Rule. -- Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.
(b) Exceptions. -- If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary or his delegate, does clearly reflect income.
(c) Permissible Methods. -- Subject to the provisions of subsections (a) and (b), a taxpayer may compute taxable income under any of the following methods of accounting --
(1) the cash receipts and disbursements method;
(2) an accrual method;
(3) any other method permitted by this chapter; or
(4) any combination of the foregoing methods permitted under regulations prescribed by the Secretary or his delegate.↩
6. Ohmer Register Co. must also be read in light of the fact that it was decided in 1942, prior to the Supreme Court's decision in Security Flour Mills Co. v. Commissioner, 321 U.S. 281, 287, which casts doubt on some of the reasoning in the Sixth Circuit's opinion in Ohmer. Cf. 131 F. 2d at 686. See also Dixie Pine Products Co. v. Commissioner, 320 U.S. 516↩.