*2115 1. An amount paid by the petitioner in 1920 to the Association of Railway Executives, of which it was a member, to cover the petitioner's share of an advertising campaign carried on by the association, held to be deductible from gross income as an ordinary and necessary business expense.
2. The respondent's determination as to the amount of income realized by the petitioner from the settlement made by it and the Director General of Railroads for materials and supplies taken over by the Director General from the petitioner, sustained.
*168 This proceeding is for the redetermination of a deficiency in income tax asserted by the respondent for the year 1920 in the amount of $9,912.84. The petitioner alleges that the respondent erred:
(1) In including in the petitioner's income the amount of $12,782.16, representing donations of property or labor by corporations or individuals for the construction of spur tracks and sidings which became the property of the petitioner.
(2) In refusing to allow the petitioner*2116 a deduction in the amount of $641.40, as an allowance for depreciation of a certain wood-preserving plant.
(3) In computing the tax to be borne by the petitioner at the rate of 10 per cent instead of computing it at 9 2/3 per cent, and leaving 1/3 of one per cent to be borne by the Director General of Railroads as his share of the tax liability for January and February, 1920.
*169 (4) In disallowing as a deduction from gross income the amount of $2,134.06, representing a portion of an assessment paid by the petitioner in 1920 to the Association of Railroad Executives.
(5) In refusing to eliminate from the petitioner's income the amount of $8,717.43, representing certain items charged to the petitioner's "Transportation and Investment" account.
(6) In adding to the petitioner's income the amount of $458,219.88 on account of property returned to the petitioner by the Director General of Railroads at the end of the period of Federal control.
At the hearing counsel for the respondent conceded the errors claimed by the petitioner in assignments 1, 2, and 3, and the petitioner withdrew assignment of error 5, thus leaving for decision only the questions raised by assignments*2117 4 and 6.
FINDINGS OF FACT.
The petitioner is a corporation with its office address at 120 Broadway, New York City. It is and was during the year 1920 engaged in operating a railroad between Los Angeles, Calif., and Salt Lake City, Utah.
During the year 1920, and for a number of years prior thereto, there was an organization known as the Association of Railway Executives, which was an association of railroad corporations, through their chief executives, owning the greater part of the railroad mileage of the United States. Its functions were conferences and cooperation with respect to matters of common interest to the railroads. The railroads were represented generally in such matters by committees or agents. The petitioner was a member of the association.
The Association of Railway Executives was organized in 1914, under another name, for the purpose of representing the railroad corporations generally in matters of common interest, but particularly and immediately in dealing with a situation resulting from a substantial and alarming decline in railroad credit. A committee of the association conferred with President Wilson in 1914, with the result that the President*2118 issued a public statement calling the attention of the county to the necessity of sustaining railroad credit and helping the railroads in every possible way, whether by private cooperative methods or by governmental agencies, and characterising the existing situation as an extraordinary emergency. This was followed by a joint resolution of Congress approved July 30, 1916, appointing a joint committee, known as the Newlands Committee, to make a comprehensive study of the whole transportation question. The association was active in presenting to this joint committee the views of the railroads as to conditions affecting railroad credit and the appropriate remedy therefor.
*170 During the period of Federal control the association represented the common interests of the railroad corporations in respect of their properties which had been taken over by the Government, conducted through its representatives the negotiations which resulted in the standard form of Federal control contract, and generally represented the common interests of the railroad corporations upon questions and matters arising between them and the Railroad Administration. During the Federal control period the*2119 association also took over the support and maintenance of certain preexisting organizations functioning in the interest of the railroads generally, and organized and supported new agencies in lieu of former organizations which had become agencies of the Railroad Administration, viz: The Bureau of Railway Economics, the Presidents' Conference Committee on Federal Valuation of Railroads, the Railway Corporate Accounting Conference, and the Railroad Corporate Engineers Association. During the year 1919 the association coordinated with said agencies and exercised a general leadership and control of all common activities in behalf of the railroad corporations. It dealt with all the practical problems with which the corporations were confronted, and was in special charge of railroad credit generally, and the problem of providing revenues adequate to enable the railroads to furnish the transportation facilities and service needed by the public.
It was the practice of the association to raise funds to defer its expenses by assessments upon the member railroads, which were usually made annually. In October, 1919, the standing committee of the association voted an assessment upon the member*2120 railroads in the amount of $1,600,000, and the chairman of the association issued under date of November 1, 1919, a call for payment thereof, one-half immediately and one-half on certain dates in 1920. The purposes of the assessment were officially stated to be to meet the cost for the year 1920 of advertising and publicity, $1,000,000; Bureau of Railway Economics, $90,000; Railway Corporate Engineers Association, $10,000; Railroad Corporate Accounting Conference, $10,000; Presidents' Conference Committee on Federal Valuation, $200,000; general and legal expenses of the association, $290,000. The appropriation of $1,000,000 for advertising and publicity was based upon a recommendation of a committee, which recommendation was distributed among the member railroads as an enclosure with the notification of the assessment. Pursuant to this assessment the petitioner paid to the association $3,414.50 in 1919 and $3,415 in 1920. These amounts were charged to operating expenses under the head of "General Expenses," and were deducted in computing net income.
*171 The association, following the making of said assessment, conducted an advertising and publicity campaign consisting*2121 of the publication of a series of eight advertisements from the middle of December, 1919, until the middle of February, 1920, at intervals of about a week, in substantially all of the daily newspapers published in the United States printed in English, and in a large number of weekly newspapers and in some farm journals and other magazines. These advertisements were prepared by publicity experts, and each one was published throughout the United States in the same text and with the same cuts and ornamental matter.
The first of said advertisements was addressed "To the American People," and had appended to it the names and official designations of the chairman and general counsel of the Association of Railway Executives and of 85 railroad officers. The text of this advertisement was as follows:
It is the declared purpose of the United States Government to restore the railroads at an early date to the control of their owners.
The Association of Railway Executives represents those upon whom at that time responsibility will again rest for the prompt and successful movement of the country's commerce.
Those constituting this association are keenly conscious of their accountability*2122 to the public.
They have accordingly determined to present as fully as they can, the fundamental facts and considerations which they themselves must face in their efforts to provide satisfactory railroad service.
It is hoped to engage the interest of the whole American people, whose welfare is so vitally dependent upon adequate transportation.
The country can grow only as the railroads grow. The railroad problem must be solved - and solved rightly and soon - if our country is to prosper.
It is to promote that prosperity - permanently and in the interest of the whole people - that railroad executives will present to the public the situation as they see it.
Each of the seven other advertisements contained the statement that it was published by the Association of Railway Executives. These seven advertisements, except for a brief text purporting to be a quotation from some public official or commission or well known private individual were as follows:
SECOND ADVERTISEMENT. - Ask any doughboy who was "over there" and he will tell you that American railroads are the best in the world.
He saw the foreign roads - in England and France, the best in Europe - and in other*2123 Continental countries - and he knows.
The part railroads have played in the development of the United States is beyond measure.
American railroads have achieved high standards of public service by farsighted and courageous investment of capital and by the constant striving of managers and men for rewards for work well done.
We have the best railroads in the world - we must continue to have the best. But they must grow.
*172 To the $20,000,000,000 now invested in our railroads, there will have to be added in the next few years, to keep pace with the nation's business, billions more for additional tracks, stations and terminals, cars and engines, electric power houses and trains, automatic signals, safety devices, the elimination of grade-crossings - and for reconstruction and engineering economies that will reduce the cost of transportation.
To attract to the railroads in the future the investment funds of many thrifty citizens, the directing genius of the most capable builders and managers, and the skill and loyalty of the best workmen - in competition with other industries bidding for capital, managers and men - the railroad industry must hold out fair rewards*2124 to capital, to managers, and to the men.
American railroads will continue to set world standards and adequately serve the Nation's needs if they continue to be built and operated on the American principle of rewards for work well done.
THIRD ADVERTISEMENT: WORK MORE - PRODUCE MORE - SAVE MORE. - But we can't continue increasing our production unless we continue increasing our railroad facilities.
The farms, mines and factories cannot increase their output beyond the capacity of the railroads to haul their products.
Railroads are now near the peak of their carrying capacity.
Without railroad expansion - more engines, more cars, more tracks, more terminals - there can be little increase in production.
But this country of ours is going to keep right on growing - and the railroads must grow with it.
To command in the investment markets the flow of new capital to expand railroad facilities - and so increase production - there must be public confidence in the future earning power of the railroads.
The nation's business can grow only as fast as the railroads grow.
FOURTH ADVERTISEMENT. - The old-time pack-bearer could carry a hundred pounds ten miles a day.
*2125 The railroad is the modern pack-bearer. For every employee it carries 2,000 times as much.
Back of each railroad worker there is a $10,000 investment in tracks and trains and terminals, with steam and electricity harnessed like a great beast of burden.
Without this mighty transportation machine the railroad worker could do no more than the old-time packer. But with it he is enabled to earn the highest railroad wages paid in the world, while the country gains the lowestcost transportation in the world.
The modern railroad does as much work for half a cent as the packbearer could do for a full day's pay.
The investment of capital in transportation and other industries increases production, spreads prosperity and advances civilization.
To enlarge our railroads so that they may keep pace with the Nation's increasing production, to improve them so that freight may be hauled with less and less human effort - a constant stream of new capital needs to be attracted.
Under wise public regulation the growth of railroads will be stimulated, the country will be adequately and economically served, labor will receive its full share of the fruits of good management, and investors*2126 will be failly rewarded.
*173 FIFTH ADVERTISEMENT. - The successful farmer raises bigger crops and cuts down costs by investment in labor-saving machinery.
Good prices for the farmers' crops encourage new investment, more production and greater prosperity.
But the success of agriculture depends on the growth of railroads - the modern beasts of burden that haul the crops to the world's markets.
The railroads - like the farms - increase their output and cut down unit costs by the constant investment of new capital.
With fair prices for the work they do, the railroads are able to attract new capital for expanding their facilities.
Rates high enough to yield a fair return will insure railroad growth, and prevent costly traffic congestion which invariably results in poorer service at higher cost.
National wealth can increase only as our railroads grow.
Poor railroad service is dear at any price. No growing country can long pay the price of inadequate transportation facilities.
SIXTH ADVERTISEMENT. - The war could not have been won without railroads. Transport - by rail and sea - is an indispensable arm of national defense.
Carrying capacity, from the*2127 wheat fields and the mines and the steel mills to the front lines in France, was the measure of our power in war.
And it is the measure of our power in peace.
Industrial expansion - increasing national prosperity - greater world trade - are vitally dependent on railroad growth.
The limit to the productive power of this country is the limit set by railroad capacity to haul the products of our industry.
The amount of freight carried on American rails doubled from 1897 to 1905 - since that year it has doubled again.
It will double still again.
To haul this rapidly growing traffic the country must have more railroads - more cars and engines - more tracks and terminals.
Sound national legislation, broad-visioned public regulation, will encourage the expansion of railroads, without which the nation cannot grow.
SEVENTH ADVERTISEMENT - CARRYING A TON A MILE FOR LESS THAN A CENT. - Freight rates have played a very small part in the rising cost of living.
Other causes - the waste of war, under-production, credit inflation - have added dollars to the cost of the necessities of life, while freight charges have added only cents.
The average charge for*2128 hauling a ton of freight a mile is less than a cent.
A suit of clothing that sold for $30 before the war was carried 2,265 miles by rail from Chicago to Los Angeles for 16 1/2 cents.
Now the freight charge is 22 cents and the suit sells for $50.
The cost of the suit has increased 20 dollars.
The freight on it has increased only 5 1/2 cents.
Other transportation charges enter into the cost of the finished article - carrying the wool to the mills and the cloth to the tailors - but these other charges amount to but a few cents more.
The $10 pair of shoes that used to sell for $5.00 goes from the New England factory to the Florida dealer for a freight charge of 5 2/3 cents - only one cent more than the pre-war rate.
*174 Beef pays only two thirds of a cent a pound freight from Chicago to New York.
American freight rates are the lowest in the world.
EIGHTH ADVERTISEMENT - THEY COULDN'T BE BUILT NOW FOR TWICE $71,000. - When the talk turns from politics to railroads, and the traveler with the cocksure air breaks in with, "Theres an awful lot of 'water' in the railroads", here are some hardpan facts to give him:
American railroads have cost $80,900*2129 a mile - roadbed, structures, stations, yards, terminals, freight, and passenger trains - everything from the great city terminals to the last spike.
A good concrete and asphalt highway costs $36,000 a mile - just a bare road, not counting the cost of culverts, bridges, etc.
Our railroads couldn't be duplicated today for $150,000 a mile.
They were capitalized for only $71,000 a mile - much less than their actual value. Seventy-one thousand dollars today will buy one locomotive.
English railways are capitalized at $274,000 a mile; the French at $155,000; German at $132,000; even in Canada (still in pioneer development) they are capitalized at $67,000 a mile. The average for all foreign countries is $100,000.
Low capitalization and high operating efficiency have enabled American railroads to pay the highest wages while charging the lowest rates.
The association expended in said advertising and publicity campaign, $714,871.34 for advertising and $113,647.06 for the services of publicity experts and artists and for other expenses incidental to the campaign, a total of $828,518.40, and the balance of the $1,000,000 appropriated for the campaign was used for the*2130 general purposes of the association. No funds of the association were expended for lobbying or were used in any way to affect the action of the Congress of the United States, except through the influence of general public opinion.
The conditions, actual and contemplated, under which said advertising and publicity campaign was undertaken, were as follows: The railroads of the country had been under Federal control since December, 1917. It was contemplated that in the near future they would be returned to their owners for private operation. The Railroad Administration had sought to operate all of the railroad properties as a unit, with the result that the rolling stock of the several railroads was scattered throughout the United States without regard to its ownership. Federal control, in the opinion of the officers of the several railroad corporations, had resulted in demoralization of the working forces and neglect of proper maintenance. Labor costs were high and were believed to be excessive. In fact, the number of railroad employees was reduced from 1,913,422 in 1919 to 1,659,513 in 1921, and by a series of orders of the Labor Board, the first of which became effective on*2131 July 1, 1921, reductions in wages were made which effected an estimated saving in labor costs of $587,000,000 per year. The managements of the railroads believed that in view of the conditions resulting from Federal control they would *175 be confronted with great difficulties in resuming private operation. They believed that they could not properly operate their properties and furnish the transportation service the public needed unless the nature of the problems confronting them and the efforts they were making to meet their transportation responsibilities were understood by the public, and unless they could receive the cooperation and support of public opinion. An hostile public opinion tends substantially to increase the cost of railroad operation through labor costs and in many other respects, and it was essential, in the opinion of the responsible officers of the railroad corporations, that they explain their problems to the public in the hope of creating an informed body of public opinion favorable to the railroads and sympathetic toward their problems.
It was known at the time said advertising and publicity campaign was undertaken that the Congress intended to enact*2132 legislation for the purpose of returning the railroads to private operation and dealing with the regulatory policies under which the railroad properties were to be operated in the future. It was believed by the managements of the railroads that such legislation, if adopted without knowledge and appreciation of the problems confronting the railroad corporations, might add greatly to the cost of operation and impair the power of the railroads to furnish adequate transportation service.
From December 31, 1917, to and including February 29, 1920, the railroad properties of the petitioner were possessed, used, controlled and operated by the United States through the United States Railroad Administration, under the direction of the Director General of Railroads, under and pursuant to the Proclamation of the President of the United States dated December 26, 1917.
The Director General and the petitioner entered into a contract dated March 10, 1919, fixing the compensation to be paid the petitioner for the use of its properties and embodying other terms and conditions governing said Federal operation and use. Said contract provided, among other things, that the petitioner's system of*2133 transportation of which the United States had taken possession, use, control and operation, included all material and supplies on hand at midnight of December 31, 1917, and all of the petitioner's material and supplies at that time were taken over by the Director General. Said material and supplies had a total book value or cost according to the petitioner's books of account of $2,647,519.92.
Said contract entered into by the petitioner and the Director General of Railroads provided, by section 9(b) thereof, that:
At the end of Federal control the Director General shall return to the Company all uncollected accounts received by him from the Company and also materials and supplies equal in quantity, quality, and relative usefulness to that of the materials and supplies which he received and to the extent that *176 the Director General does not return such materials and supplies he shall account for the same at prices prevailing at the end of Federal control. To the extent that the Company receives materials and supplies in excess of those delivered by it to the Director General it shall account for the same at the prices prevailing at the end of Federal control, and the*2134 balance shall be adjusted in cash.
The 1917 inventory, that is, the material and supplies taken over from the petitioner by the Director General, included materials and supplies that were replaced in kind at the end of Federal control, and material and supplies for which cash settlement was made by the Director General. The book value of the 1917 inventory was not segregated to ascertain the book value separately of the material and supplies replaced in kind and of the material and supplies for which cash settlement was made.
At the end of Federal control on March 1, 1920, the Director General returned to the petitioner material and supplies having an aggregate book value or cost, according to the material and supplies accounts of the Director General, of $2,365,336.89. The Director General also paid the petitioner $740,402.91 in full settlement of the Government's obligation to pay for material and supplies taken over from the petitioner and not replaced in kind. The material and supplies turned over to the petitioner on March 1, 1920, did not in their entirety represent replacements in kind, but included excess material and supplies for which the petitioner was charged in*2135 the final settlement at the market prices then prevailing. Neither the book value nor the market value of the replacement material and supplies was separately ascertained. The book value of the excess material was more than $459,000.
The respondent, upon audit of the petitioner's income-tax return for 1920, disallowed as a deduction from gross income ten-sixteenths or $2,134.06 of said amount of $3,415, paid by the petitioner in 1920 to the Association of Railway Executives as above set forth, and he also determined that the petitioner realized a profit of $458,219.88 on the settlement between it and the Director General for material and supplies, which profit he computed as follows:
| Value of material and supplies turned over to the | ||
| Director General of Railroads, Jan. 1, 1918 | $2,647,519.92 | |
| Less amount allowed in final settlement for net | ||
| shortage of units | $813,761.57 | |
| Adjustments of prices of materials and supplies | ||
| used in additions and betterments | 73,358.66 | |
| 740,402.91 | ||
| 1,907,117.01 | ||
| Value of material and supplies taken over from the | ||
| Director General of Railroads, Feb. 29, 1920 | 2,365,336.89 | |
| Net increase | 458,219.88 |
*177 *2136 The respondent also made other adjustments in the petitioner's income for 1920 which are not material here, and determined that there is a deficiency in tax in the amount of $9,912.84.
OPINION.
MARQUETTE: The first of the issues that we are called upon to consider in this proceeding is whether the respondent erred in disallowing as a deduction from gross income for 1920, ten-sixteenths, or $2,134.06, of the amount of $3,415 paid by the petitioner to the Association of Railway Executives. This question was before the Board in ; ; and . Under the pleadings in those cases the burden was upon the respondent to show that the petitioners were not entitled to the deductions they had taken, and, the respondent having failed to meet the burden, our decisions were in favor of the petitioners. This is, therefore, the first proceeding in which the question is presented for determination on its merits.
It appears from the evidence that the Association of Railway Executives is an association of railroad corporations, *2137 acting through their chief executives, formed for the purpose of promoting the welfare of the railroads and of representing and acting for them in matters of common interest. These activities were supported by the member railroads through contributions or assessments, and it is the assessment paid by the petitioner in 1920 which is the subject matter of this issue.
The respondent has not disallowed as a deduction from gross income the entire amount of the assessment, but only that part thereof which was used or intended to be used by the association in the advertising and publicity campaign described in the findings of fact. He contends that the disallowance is proper under article 562 of Regulations, 45, which provides, among other things, that:
Sums of money expended for lobbying purposes, the promotion or defeat of legislation, the exploitation of propaganda, including advertising other than trade advertising, and contributions for campaign expenses, are not deductible from gross income.
It is clear that the purpose of the advertising and publicity campaign conducted by the association was to create a body of intelligent public opinion favorable to the railroads of the*2138 country, and to avert the enactment of legislation unfavorable or injurious to them. The campaign was made by carrying in the newspapers of the country a series of advertisements setting forth the services rendered by the railroads, the problems confronting them, and suggesting sound legislation and wise regulation.
*178 The regulation quoted above contains no definition of the words "lobbying" and "propaganda," as they are used therein. These words are often employed to convey a sinister meaning and to suggest illegitimate activities or illegal and unethical methods. However, all activities which may properly be considered as coming within the scope of these terms are not illegal.
In , the petitioner was a member of brewery associations organized and legally conducted for the purpose of furthering the interests of its members. In 1919 the petitioner paid dues to the Western Pennsylvania Brewers Association, the Westmoreland County Association, and the United States Brewers Association. In addition, it paid to the last-named association $8,340.16 as its pro rata share of the fees of attorneys employed by the United*2139 States Brewers Association to test the constitutionality of the prohibition amendment to the Constitution. In holding that the amounts paid by the petitioner to the several brewery associations, including its share of the attorneys' fees, were deductible from its gross income, we said:
We think that the amounts paid constituted ordinary and necessary expenses. All of the brewers associations mentioned were, so far as the record indicates, performing lawful services for their members and such services were in furtherance of the members' business. It does not appear from the record that the taxpayer was under any legal obligation to make a contribution for the attorneys' fees, but it was perfectly legal for the brewers' association to test the constitutionality of the prohibition amendment and the payment by the taxpayer of its proportion of the fees was an ordinary and necessary expense of doing business.
In , the petitioner, a manufacturer of beer, contributed to the Lager Beer Board of Trade to cover the expenses of employing counsel to test the constitutionality of the prewar prohibition legislation and to carry on a campaign*2140 against assertions made by the Anti-Saloon League that the brewers were wasting food products. In that case we said:
The money paid to the Lager Beer Board of Trade was expended by it and the United States Brewers Association for the benefit of the petitioner. We are of the opinion that the expenditure was for a purpose coming within the provisions of the taxing act allowing a deduction for ordinary and necessary expenses paid or incurred in carrying on a trade or business.
In , the petitioner was engaged in buying and selling gasoline, oils, greases, and benzol, and in selling a motor fuel consisting of benzol and gasoline and known as Woco Pep. Because of the ingredients of Woco Pep the standard test for gasoline could not be applied to it. In 1919 or 1920 the Governor of Alabama called a special session of the Legislature, one of the purposes of such session being the enactment of legislation covering motor fuels and gasoline, with provision for an inspection *179 fee or charge. The petitioner knew that an inspection bill fixing standards of motor fuel for the State of Alabama, based on tests of high-grade gasoline, *2141 would prohibit the sale of Woco Pep. Realizing that if a bill of the kind proposed were adopted by the State of Alabama he would be put out of business, the petitioner employed an attorney for the purpose of forestalling, to the best of his ability, the proposed adverse legislation. The attorney drafted an inspection bill containing regulations and provisions that would permit the sale of Woco Pep in Alabama, and he appeared before the Governor and the Attorney General of Alabama in behalf of the bill drafted by him. He also appeared before the several committees of the Legislature to which the bill drafted by him was referred, and explained the bill and advocated its passage. The petitioner paid the attorney $7,750 for his services. In holding that the amount so paid was an ordinary and necessary business expense and deductible in computing net income this Board said:
A special session of the Legislature of Alabama had been called by the Governor and one of the purposes of such session was the passage of a bill covering motor fuel and gasoline, with provision for an inspection fee or charge. Petitioner knew that an inspection bill fixing the standards of motor fuel for the*2142 State of Alabama based on tests of high-grade gasoline would prohibit the sale of Woco Pep, which was the principal product of his business and, in order to keep his business alive, he employed an attorney to protect his interest in connection with the legislation. The expense was an ordinary and necessary one and the services which the attorney was employed to render were entirely legitimate. The deduction is allowed.
We are unable to perceive any vital difference between the situations in the cases cited and that which gives rise to the present inquiry. There is no difference in principle between an expenditure of money to invalidate legislation already enacted and an expenditure to avert or forestall the enactment of legislation, assuming that in each instance the means or methods employed are legitimate. Nor do we see any distinction between an undertaking by an individual or corporation to avert or defeat, by direct action, legislation unfavorable to or destructive of his or its business, as in the Wofford case, and a joint undertaking by a number of individuals or corporations to avert or defeat, by indirect action, legislation unfavorable to or destructive of their*2143 business. We are of opinion that the expenditure in question was for a legitimate purpose vitally connected with the welfare and for the benefit of the petitioner's business, that it was made in a legal and ethical manner, and that it was an ordinary and necessary expense of the petitioner's business within the meaning of the revenue act then in force and should be allowed as a deduction from gross income.
The other issue that we are called upon to decide relates to the amount of income, if any, that the petitioner realized upon the material *180 and supplies settlement made by and between it and the Director General of Railroads. The respondent has determined that the profit on the settlement was $458,219.88, which he computed in the manner and on the basis set forth in the findings of fact. It is the contention of the petitioner that in the "1920 Inventory," which means all the material and supplies delivered by the Director General to the petitioner at the end of Federal control, there was included "Excess Material," that is, material which was in excess in physical quantity of material of like kind in the "1917 Inventory," and for which the petitioner was required*2144 to pay at the market price prevailing at the end of Federal control; that excluding from the "1920 Inventory" the value of the "Excess Material," which was more than $459,000, the remaining value of the "1920 Inventory" would not exceed the book value of that part of the "1917 Inventory" which was replaced in kind, and, that therefore, the petitioner realized no profit from the settlement. The petitioner also contends that even if the "1920 Inventory" be considered as wholly "Replacement Material," the increased value does not constitute taxable income or profit, citing . Under the facts as disclosed by the record herein the petitioner's contention as to this issue is not well taken. The situation is entirely different from that found in , for in this case a cash settlement is involved which was not present in that case. Nor does the fact that the "Excess Material" is included in the "1920 Inventory" affect the result. It is true that the "Excess Material" should be excluded from the "1920 Inventory," but the amount of the "Excess Material" should be added to*2145 the cash settlement to reflect the "Short Material" for which the Director General accounted to the petitioner at the prices prevailing at the end of Federal control. This is obvious from the contract, which provides that the Director General shall account for "Short Material" and the petitioner pay for "Excess Material" at the prices prevailing at the end of Federal control, and that the "balance shall be adjusted in cash." Making this adjustment, the "Replacement Material," plus the value of the "Short Material," computed at prices prevailing at the end of Federal control, would still be in the total amount of $3,105,739.89.
The profit or loss from the settlement can be computed as follows: The items of "Replacement Material" and their cost or book value, should be excluded from the "1917 Inventory," but the cost to the petitioner of the "Excess Material" should be added to the amount of the cash settlement, and the difference between the "1917 Inventory" thus reduced and the sum of the cash settlement and "Excess Material" is profit or loss, depending upon whether the *181 sum of the cash settlement and the "Excess Material" is greater or less than the reduced "1917 Inventory. *2146 "
The respondent has determined that the petitioner realized a profit of $458,219.88 from the settlement in question. The burden of showing the respondent is in error is upon the petitioner. It has failed to meet that burden and we have before us no evidence that would justify us in disturbing the respondent's determination. The "Replacement Material" and the "Excess Material" were not segregated and separately inventoried, and we are not informed as to whether the "Replacement Material" is included in the "1920 Inventory" at a greater or a less value than in the "1917 Inventory" or is included at the same value in both inventories. Excluding from the "1920 Inventory" the value of the "Excess Material" as suggested by the petitioner, but adding the same amount to the cash settlement, the situation, on the record before us, is that the petitioner in 1917 turned over to the Director General material and supplies having a cost or book value of $2,647,519.92 and in 1920 received from the Director General material and supplies and cash having a total cost or value of $3,105,739.80. The excess of the property and cash received at the end of Federal control over the cost or book value*2147 of the property turned over to the Director General, was $458,219.88, and to the extent that it was represented by cash it constituted income to the petitioner. . The respondent's determination as to this item is approved.
The petitioner's tax liability for 1920 will be recomputed on the basis of this opinion and the agreements as to the other issues made by counsel at the hearing.
Reviewed by the Board.
Judgment will be entered under Rule 50.