*2108 1. The petitioner held to have realized no profit in 1920 from the sale of a certain sawmill and timber property involved herein.
2. The respondent's action in regard to the petitioner's closing inventory for 1920 sustained.
*125 This proceeding is for the redetermination of a deficiency in income and profits taxes asserted by the respondent for the year 1920 in the amount of $32,985.73. The petitioner alleges that the respondent erred in including in the petitioner's income for 1920 the profit arising from the sale of a certain sawmill and certain timber belonging to the petitioner, and in failing to use the market value of certain lumber in computing the petitioner's closing inventory for 1920.
FINDINGS OF FACT.
The petitioner is a Tennessee corporation with its principal office at Memphis. For a number of years prior to 1920 it was engaged in logging and lumber manufacturing, and it owned a sawmill at Batesville, Miss., and large tracts of hardwood timber in that vicinity.
*2109 At the beginning of the year 1920 there was a favorable market for lumber and the petitioner's officers decided to dispose of its sawmill and to devote all of their efforts to the timber and logging business. They believed that they could sell the Batesville mill to *126 advantage at that time because of the high price of lumber and because of the quantity of timber that the petitioner then had available to that mill.
The petitioner's officers estimated that the timber tracts owned by it contained from 50,000,000 to 60,000,000 feet of hardwood timber. As the operation of the sawmill continued and the timber was further depleted, the market value of the sawmill was reduced proportionately. In view of the circumstances the petitioner made it known that its sawmill property would be sold and that its timber holdings would be available to the purchaser of the sawmill.
About January 15, 1920, the petitioner began the negotiation for the sale of its sawmill property with William Pritchard and C. M. Kellogg, who were acting for themselves and others. Pritchard and Kellogg and their associates had obtained a valuable contract for the sale of manufactured hardwood lumber*2110 and, in order to carry out this contract, it was necessary that they should immediately acquire a sawmill and an ample and assured supply of timber.
The petitioner, through R. H. Darnell, its president, and H. A. Darnell, vice president and secretary, offered to sell its sawmill property for $275,000 and to deliver logs from its timber land at a price to be agreed upon. The salvage value of the mill was estimated by the parties to the negotiation at $25,000, and they estimated that depreciation of $5 per thousand feet of logs handled could be absorbed in manufacturing costs and leave a reasonable profit to the purchaser.
A cruise of the timber owned by the petitioner had not been made and could not be made at that time because of the flooded condition of the land. Furthermore, Pritchard and Kellogg and their associates could not, on account of their contracts to supply lumber, wait for a cruise to be made. It was estimated, however, that the petitioner's timber tracts, which covered about 19,200 acres, contained from 40,000,000 to 60,000,000 feet of timber. Pritchard and Kellogg were willing to pay $275,000 for the sawmill property if the petitioner would contract to deliver*2111 60,000,000 feet of timber. This the petitioner was unwilling to do.
The negotiations were concluded with the understanding that the price of the sawmill property was to be based upon the quantity of timber delivered by the petitioner: $225,000 if the petitioner delivered 40,000,000 feet of timber; $2,500 for each 1,000,000 feet delivered in excess of 40,000,000 feet, and not in excess of 60,000,000 feet, and a refund or rebate to the purchaser of $10 for each 1,000 feet by which deliveries should fall short of 40,000,000 feet. Pritchard and Kellogg refused to purchase the mill unless the petitioner would guarantee delivery of a minimum of 40,000,000 feet of logs.
*127 Pursuant to the understanding or oral agreement arrived at by the petitioner's representatives and Pritchard and Kellogg, the following written agreement was entered into by the petitioner and Pritchard and Kellogg, as trustees, on January 26, 1920:
MEMORANDUM OF AGREEMENT, entered into on this the 26th day of January, 1920, by and between R. J. Darnell, Inc., a corporation organized and existing under the laws of the State of Tennessee with its domicile at Memphis, hereinafter referred to as the first*2112 party, and William Pritchard and C. M. Kellogg, Trustees, both residing at Memphis, Tennessee, hereinafter referred to as the second party, WITNESSETH:
I.The first party hereby sells and agrees to convey by appropriate legal conveyance (authorized by said corporation) to the second party, or to any person, persons or corporation (not prohibited by law from holding lands), that the second party may name subject to the terms, conditions and agreements hereinafter set forth, the following described real property situated in Panola County, State of Mississippi, and more particularly described as follows:
(1) "All of that part of the South half of the Northeast quarter of Section eighteen (18), Township nine (9) Range seven (7), west, which lies South of the right of way of the Batesville Southwestern Railroad Company, except that part of same described as follows: Beginning at the Southeast corner of the said Northeast quarter and running thence North 442 feet; thence West 663 feet; thence South 442 feet; thence East to the beginning, containing 42.6 acres."
And except the following:
(a) That particular triangular piece of land lying South of the Batesville Southwestern Railroad*2113 and bounded on the South by the private gravel road and Vance's Creek, containing approximately 3.23 acres of land, and situated in the Northeast corner of said 42.6-acre tract hereinbefore described, and more particularly designated by a blue print attached hereto marked exhibit "A" and made a part of this contract.
(b) A right of way fifty (50) feet wide is expressly reserved over said 42.6-acre tract for the location of a spur track to connect the Batesville Southwestern with the gravel deposits located on the South side of said 42.6-acre tract. The location of said track will be agreed upon between the parties hereto in the future, but it is to intersect the main line of the Batesville Southwestern at a point between the bridge over Vance creek, and the public highway running North and South, east of said property and known as the Blue Pond public highway.
(c) This conveyance is also made subject to the terms of the lease contract between R. J. Darnell, Inc., and B. E. Boothe, dated January 3, 1914, covering the site for a commissary building as is more particularly described in said lease contract, which said lease contract will be assigned and transferred by the first*2114 party to the second party herein.
(d) It is expressly understood between the parties hereto that the railroad water tank located on the 42.6-acre tract of land hereinbefore described is not embraced in this sale, but it is understood and agreed between the parties hereto that the said water tank shall be treated as personal property, owned by the Batesville Southwestern Railroad, and said railroad shall have the privilege at any time in the future, if it so desires, to remove said tank.
(e) It is furthermore understood and agreed between the parties hereto that the railroad switches and spur tracks now located in and upon the said *128 42.6-acre tract of land hereinbefore described, is the property of the Batesville Southwestern Railroad and is not embraced in this sale, but is expressly reserved therefrom, but the second party herein agrees to execute a regulation spur track contract between themselves and the Batesville Southwestern Railroad for the future use and maintenance of said switches and spur tracks, said contract to be tendered with deeds.
(2) First party also agrees to sell and convey by Warranty deed the following tract of land in said County and State:
*2115 "Beginning on the East line of the right of way of the Chicago, St. Louis and New Orleans Railroad Company, now leased and operated by Illinois Central Railroad Company, at a point where the line between Sections 8 and 17 of Township 9, Range 7, West, intersects said east line of said right of way, and running thence east with said section line thirteen (13) chains and 44 links; thence due south 12 chains and 64 links; thence due west 6 chains and 72 links; thence due south 1 chain and 64 links; thence due west 10 chains and 10 links to stake on the east line of said right of way; thence north with said east line of said right of way 14 chains and 75 links to beginning, containing 20 and 73/100 acres, more or less, except 5 and 73/100 acres conveyed by W. P. Burbridge to H. L. Pollard by deed of record on page 130 of book "C" of records of deeds of said district of said County. Vendor's lien retained. A strip of 20 feet wide is reserved off the west side of the land hereby conveyed and adjoining the said right of way of said railroad company for street and road purposes and public highway."
(3) First party also agrees to sell and convey by warranty deed the following tract of*2116 land in said County and State:
"Lot in town of Batesville described as: Beginning at a point that is 14 chains and 84.9 links north and 12 chains and 52 links west of the Southeast corner of Section 8, Township 9, Range 7, West, and running thence South 17 degrees east with east edge sidewalk 139.5 feet to center of concrete steps; thence north 73 degrees east 200 feet; thence north 76.2 feet; thence west 232 feet to beginning, being a part of Block 'M' of said town."
(4) The first party hereby sells and assigns to the second party all of its right, title and interest in and to a certain lease contract executed between the first party and C. B. Vance covering two houses located on the said Vance lands, which lie immediately east of the 42.6 acre tract of land hereinbefore described, which said lease is referred to and made part hereof as if fully set forth herein. First party will assign and deliver same to the second party.
First party agrees to furnish necessary abstracts brought down to date, showing a good merchantable title in the first party to the above described real estate and to correct any reasonable defects that may be found therein.
The first party hereby sells*2117 and agrees to deliver to the second party the following personal property:
(1) All machinery, together with all tools, supplies and equipment of every kind and character belonging to the sawmill plant now located on the 42.6-acre tract of land hereinbefore described and to be found in the boiler house, engine rooms and sawmill building, planing mill building, blacksmith shop and oil house. Also all lumber trucks and transfer trucks used in transporting lumber from the mill to and about the lumber yard, and also the steel rails and fastenings in and about said sawmill building, platforms and sheds in the lumber yards, but this does not include the steel rails and fastenings in the railroad switch and spur tracks on said property. Also lumber stacking sticks, covering boards and foundations, one Ford automobile truck, one wagon, one cart, two mules and two sets of harness.
*129 It is expressly understood, however, that all tools, machine parts and supplies now stored in said sawmill plant which are owned and required for the use of the first party's logging operations, are not embraced in the foregoing personal property, but are expressly exempted therefrom.
It is further*2118 understood that the first party reserves the two wire machines now in said plant and they are hereby expressly exempted from this sale. Also all railroad track, car or locomotive repairs or parts which are now stored in said plant are expressly reserved by first party and not embraced in this sale.
It is further understood between the parties hereto that all the lumber and logs now stored on said mill property are reserved by the first party and not embraced in this sale.
Also:
(2) All of the office furniture and outfit now found in the office building at said mill site are hereby sold and delivered to the second party, except one five and one-half (5 1/2) foot roll-top oak desk, three chairs, and one drawing board, same being located in the office of the General Manager of the first party; all catalogue cabinets; all filing cabinets; all correspondence and office records of every kind, character and description now in said office building on said sawmill property.
II.It is further understood and agreed between the parties hereto that the first party agrees to sell the foregoing described real and personal property and the second party agrees to pay therefor, the sum*2119 of TWO HUNDRED AND TWENTY-FIVE THOUSAND DOLLARS ($225,000.00) upon the following terms, to-wit:
(1) (a) TWENTY-FIVE THOUSAND DOLLARS ($25,000.00) cash on the signing of this contract;
(b) FIFTY THOUSAND DOLLARS ($50,000.00) on delivery of warranty deeds to the hereinbefore described real property;
(c) Three notes as follows:
One note for Twenty-five Thousand Dollars ($25,000) due in six monhs, bearing interest at six per cent from date;
One note for Fifty Thousand Dollars ($50,000.00) due one year from date, bearing interest at six per cent from date;
One note for Seventy-five Thousand Dollars ($75,000.00) due in two years from date, bearing interest at six per cent from date;
Interest payable annually at the option of the markers.
(2) When the first party tenders deeds to the foregoing described property, free from all liens, contracts, debts and encumbrances of every kind, except those specifically provided for herein, showing a good merchantable title to said property, then the second party agrees to accept the same.
(3) It is understood and agreed between the parties hereto that a trust deed shall be executed by the second party securing the first party for*2120 the unpaid part of the purchase money and other obligations assumed hereunder by the second party.
(4) The second party further agrees, as an additional protection to the first party, to carry an adequate amount of liability insurance, boiler insurance, fly-wheel insurance and fire insurance, with responsible and respectable insurance companies, acceptable to the first party. Said fire insurance policies to cover not less than eighty per cent (80%) of the reasonable value of the property insured and such policies to contain a clause whereby the loss, if any, shall be payable to the first party as its interest may appear, and said fire *130 insurance policies shall be delivered and turned over to the first party and held by it until the purchase money and all obligations assumed by the second party hereunder are fully discharged. It is agreed, however, that if the mill property conveyed herein should be destroyed by fire and the insurance money collected by the first party herein that the second party shall have the right to use said insurance money, if they so desire, in the reproduction of said property, but all disbursements for this purpose shall be made by and through*2121 the first party. It is further agreed that during the construction of said new property, and after the same is completed, that a like amount of insurance shall be secured upon the same as hereinbefore provided, and said policies shall contain the loss clause payable as herein provided.
(5) It is understood and agreed between the parties hereto that the first party is under contract with the Batesville Southwestern Railroad and the Batesville Gravel and Material Company to, at all times, supply the railroad water tank now located on the 42.6-acre tract hereinbefore described, with sufficient water for steam purposes and to furnish water under pressure direct from the high mill tank for the purpose of washing out boilers and for other purposes, and for such services the Batesville Southwestern Railroad is to pay the sum of TWENTY-FIVE DOLLARS ($25.00) per month, and this contract is to continue so long as the sawmill plant is maintained on the properties hereinbefore described, during the life of this contract, but in no event longer than June 30, 1930. The bills for such services are to be rendered each month to the Batesville Southwestern Railroad and are to be paid according*2122 to the terms of a contract to be entered into between the second party and the Batesville Southwestern Railroad covering the services above enumerated, and this obligation shall be binding upon second parties, assigns, vendees, administrators and executors and successors in title to said property.
III.(1) As a part of the consideration for the purchase by the second party of the property hereinbefore described, the first party hereby sells and agrees to deliver a minimum of forty million (40,000,000) feet of logs, f.o.b. cars at any point on the Batesville Southwestern Railroad, to grade No. 2 and better. Said logs to be cut from timber now located on the lands owned by the first party in Panola, Tallahatchie and Quitman Counties, and more particularly described, and out of which logs can be secured of the dimensions and grades
The first party further agrees to deliver an additional twenty million (20,000,000) feet of logs making a total of sixty million (60,000,000) feet, provided there is timber sufficient from which to cut said logs on the lands just described, and out of which logs can be secured of the dimensions and grades hereinafter described and for the prices hereinafter*2123 mentioned, and the first party shall have the option, if it desires to exercise it, of purchasing logs or timber from which logs can be cut, to furnish the said additional twenty million (20,000,000) feet in the event there is not timber sufficient on the lands now owned by the first party to produce said quantity of logs. It is agreed, however, that if the first party should purchase timber adjacent or accessible to Batesville Southwestern during the life of this contract, that it will apply the same on the sixty million (60,000,000) feet or any part thereof herein provided for.
(2) First party agrees to deliver to second party, in the manner hereinbefore described, said logs at the rate of not less than fourteen million (14,000,000) *131 feet, nor more than eighteen million (18,000,000) feet per annum from the date of this contract; such annual deliveries to be as nearly as practicable in monthly installments in no event to be less than one million (1,000,000) feet, nor more than two million (2,000,000) feet for each calendar month, provided, however, that such deliveries are not prevented by fire, floods, strikes, labor troubles, water conditions, breakage of machinery, *2124 car supply and other unavoidable conditions over which the first party can have no reasonable control. In the event the first party is so prevented from making the required deliveries each month, then the first party shall have the right to make additional deliveries during subsequent months which shall be applied as credits on the previous months when the total amount of logs were not delivered as hereinbefore provided. It is agreed, however, that the first party is to exercise diligence and care in loading old logs ahead of freshly cut logs in order to reduce the deterioration of said logs to a minimum.
It is further agreed that if the second party shall be prevented from receiving the logs in the quantities provided for herein, due to fire, strikes, labor troubles, breakage of machinery and other unavoidable conditions over which the second party has no reasonable control, then the second party is to be relieved from receiving logs during the continuance of such unavoidable conditions, but the second party is to exercise due diligence to prevent such conditions from arising and to exert reasonable efforts to correct such conditions and promptly prepare for the reception of*2125 logs agreeable to the terms of this contract. Any logs already cut, however, shall be paid for when inspected according to the terms of this contract.
(3) All logs to be delivered under this contract shall grade No. 2 and better, and shall be inspected and measured at the log dumps within seventy-five (75) feet of the center of the Batesville Southwestern Railroad, or of the spur tracks belonging to the first party, and such logs shall be graded in accordance with the rules and regulaions of the Southern Logging Association of Memphis, Tennessee, as such rules and regulations exist at the date of this contract, and a copy of which rules and regulations is hereto attached and marked Exhibit "C" and made a part of this contract.
It is agreed, however, that said rules and regulations shall be amended as follows:
All logs measuring up to and including five-eighths (5/8) inch in diameter over the even inch shall be "called back" to the even inch, and all logs measuring over five-eighths (5/8) of an inch in diameter over the even inch shall be "called forward" to the next higher even inch.
It is agreed that said log inspection and measurement is to be joint and each party hereto*2126 is to pay his own cost of inspection. Such inspection is to be had as frequently as either party calls for it and if either party fails to have a representative present when inspection is required, then the other party is to accept the scale and measurement made by the first party of all such inspections and measurements. In the event, however, a disagreement arises as to the grade and measurement of logs and the parties hereto are unable to reach an agreement between themselves, then the matter in dispute shall be the subject of arbitration as hereinbefore provided.
(4) The second party agrees and promises to pay to the first party for said logs on the 10th day of each month, following the inspection at said dumps hereinbefore mentioned, for all logs inspected and measured during the previous calendar month, but not in excess of the maximum delivery provided in paragraph *132 2, page 10 hereof, and the prices to be paid for said logs during the first six months of this contract are as follows:
| WHITE OAK: | |
| Cow Oak and Forked Leaf Oak, 16" to 23" in diam | $45.00 per 1,000' |
| Cow Oak and Forked Leaf Oak. 24" and upward diam | 65.00 per 1,000' |
| Overcup and Post Oak, 16" to 23" in diameter | 30.00 per 1,000' |
| Overcup and Post Oak, 24" and upward in diameter | 50.00 per 1,000' |
| RED OAK, 16" and upward in diam | 35.00 per 1,000' |
| RED GUM, 21" and upward in diam | 35.00 per 1,000' |
| ASH, 16" and upward in diameter | 60.00 per 1,000' |
| ELM, 16" and upward in diameter | 35.00 per 1,000' |
| COTTONWOOD, 16" and upward in diam | 35.00 per 1,000' |
| POPLAR, 16" and upward in diameter | 50.00 per 1,000' |
| CYPRESS, 10" and upward in diameter | 35.00 per 1,000' |
| BLACK GUM, 21" and upward in diam | 20.00 per 1,000' |
*2127 The prices in the foregoing schedule are to obtain for six months from January 31, 1920, and prices thereafter shall be fixed for each succeeding six months, within thirty days after the termination of the last preceding six months period; said prices for each species and size of logs to be fixed for each succeeding six months period with the same relation to the wholesale market price of log-run lumber of each kind of wood above enumerated which then obtains at Memphis, Tenn., on the date of the beginning of said six months period, as the present schedule of log prices, fixed herein, bear to the present market price at Memphis, Tennessee, of log-run lumber of the several kinds of wood specified herein, and a schedule setting forth the present market prices of log-run lumber at Memphis is attached hereto and marked Exhibit "D" and made a part hereof.
It is expressly agreed that the failure to promptly fix said schedule of prices as above provided, or if the matter should become the subject of arbitration, neither of such conditions shall cause or justify either party hereto in failing to carry out the provisions of this contract and settlement of logs in the meanwhile delivered, *2128 shall be at the prices thereafter fixed either by agreement or resulting from arbitration, as herein provided.
(5) As a part of the consideration for the purchase of the properties hereinbefore described by the second party, the first party agrees and binds itself, its successors and assigns, to deliver, as above provided, a minimum of forty million (40,000,000) feet of logs of specified grades, and in the manner already provided for, and as an inducement for additional deliveries in excess of said forty million (40,000,000) feet of logs the second party agrees and obligates themselves to pay to the first party the sum of TWENTY FIVE HUNDRED ($2500.00) dollars for each million feet over and above said minimum of forty million (40,000,000) feet, and not in excess of the additional twenty million (20,000,000) feet of logs which may be delivered to it over and above the Forty Million (40,000,000) feet guaranteed to be delivered hereunder. Said Twenty-five Hundred ($2500.00) Dollars for any million feet as a premium just provided for is to be in addition to the prices hereinbefore agreed upon for the first six months period of the life of this contract, and over and above the prices*2129 that may be fixed for any succeeding six months period, and further, that said additional Twenty-Five Hundred Dollars ($2500.00) premium so paid as just provided for, shall not be taken into consideration in fixing the prices for any succeeding six months period between the parties hereto, or in the event the fixing of the prices should be submitted to arbitration, and it is also agreed that in the event of arbitration the Twenty-five Hundred Dollars *133 ($2500.00) premium so provided for on each additional million (1,000,000) feet so furnished, shall not be offered in evidence before the arbitration, nor considered by said arbitrators in fixing the price of logs. Such additional deliveries to begin when the forty million (40,000,000) feet is completed, then continuously according to terms of this contract.
It is further agreed between the parties hereto that said additional sum of Twenty-five Hundred Dollars (2500.00) premium for logs so delivered in excess of the Forty Million (40,000,000) feet minimum shall become due and payable upon the delivery of each additional million feet under the terms of this contract.
(6) The first party agrees in the event it fails to*2130 deliver said minimum amount of Forty Million (40,000,000) feet of logs as herein provided, that it will pay to the second party the sum of Ten Dollars ($10.00) per thousand feet for each and every one million (1,000,000) feet less than the Forty Million (40,000.000) feet minimum which it has contracted to deliver.
This clause shall not be construed and is not intended to release or discharge the first party from its obligations to deliver said minimum of Forty Million (40,000,000) feet, and the said Ten Dollars ($10.00) per thousand feet shall not be construed to release the first party from its obligations to deliver not less than Thirty Million (30,000,000) feet.
(7) It is understood by the first party that the second party is to operate said sawmill and manufacture said logs into lumber; and to employ large force of employees to manufacture and handle the same, for it is contemplated by the second party to sell the manufactured product of logs at a profit and such operations and profits are directly in contemplation of the parties hereto, and therefore, the prompt delivery of said logs by the first party as herein provided is made an essential part of this contract.
It*2131 is further agreed that a failure to deliver said logs as herein provided shall be treated as a recurrent liability, and the second party may make demand for damages which may accrue by reason of the failure of the first party to make deliveries as herein provided when a breach occurs, but notice in writing must be given to the first party and demand for damages within thirty days from the date of said breach; such breach or breaches, however, to be subject to the conditions already described herein such demand, or any suit that may be brought to enforce such demand, shall not be construed as a termination of this contract, but merely a settlement pro tanto and said demands or suits may be made as often as the breach of said contract occurs, but failure to bring suit on such demand shall not be construed a waiver, provided, however, all suits shall be brought within one year from such written demand.
(8) It is further agreed and understood between the parties hereto that in order for the first party to make prompt deliveries of logs agreeable to the terms of this contract as provided in the section immediately preceding, that the second party must promptly unload the logs on*2132 delivery at their mill plant and the second party agrees that if they fail, neglect or refuse to promptly unload any and all cars of logs when so delivered that they will be liable to the first party for all damages that result from each and every delay in so unloading cars. It is, therefore, agreed between the parties that prompt unloading of cars shall be made an element of time in the carrying out of this contract, and the second party obligates itself to promptly and diligently unload and release said cars loaded with logs when delivered at its mill plant. Such breach by second party shall not terminate this contract, but they shall be answerable in damages for the same.
*134 IV.
In the event the parties hereto should fail to agree (a) as to the inspection of the logs as provided for herein, or (b) as to the market price of log run lumber in the City of Memphis, as a basis for fixing the six months schedule of the prices to be paid for said logs, or (c) as to any other of the terms or conditions of this agreement, such question or questions shall be submitted to arbitration in the following manner:
Either party may demand such arbitration by giving written notice*2133 thereof to the other party, setting forth therein the point or points in dispute, and the name of some person appointed by it to act as arbitrator. The party upon whom such notice is served shall appoint a second arbitrator and give the party demanding the arbitration notice in writing of such appointment within ten (10) days from time such notice is received. The two arbitrators so chosen shall appoint a third arbitrator, and if they do not agree upon a third arbitrator within thirty (30) days of the time of notice of the appointment of the second arbitrator, such third arbitrator shall be appointed, upon the application of either party thereto, by the Judge of the United States District Court, for the time being, of the district in which Memphis, Tennessee, is situated; and in case of the refusal or neglect of either party to appoint a second arbitrator within ten (10) days after it shall have been given written demand for arbitration as aforesaid, then a single arbitrator appointed by the party demanding such arbitration, shall, at the request of the party appointing him, proceed to hear and determine the matter as if he were the arbitrator appointed for that purpose by both the*2134 parties hereto, and the three arbitrators so chosen, or the said arbitrator, if there be but one, shall proceed at once to hear and determine the matter in controversy, after giving to each of the parties reasonable notice, of which the arbitrators or arbitrator shall be the judge of the time and place of hearing. If any arbirator shall decline or fail to act, the party or persons by whom he was chosen shall appoint another to act in his place. All the arbitrators appointed shall be competent persons, wholly disinterested in the matter in controversy, and in no way connected with either of the parties hereto, and if the question of decision relates to any question affecting the grade of logs, or price of lumber for fixing the price of logs, said arbitrators shall be actively engaged in the manufacture and/or wholesale of hardwood lumber. The decision or the award of the arbitrators or of a majority of them or of the said arbitrator, if there shall be but one, made in writing, after hearing the parties or party who shall have attended in compliance with notice given as above required, shall be final and binding upon the respective parties hereto. In arbitrations under this agreement*2135 each party shall be responsible for the compensation of the arbitrator acting on its behalf, and the compensation of a third arbitrator shall be paid one-half by each of the parties hereto.
V.It is agreed between the parties hereto that in making the maximum deliveries of logs provided for in paragraph 2, of section 3, page 10, herein, that such maximum deliveries should be made in the Fall and Winter months when the deterioration of logs is at the minimum. If, however, the second party should request in writing the maximum deliveries or any part thereof in excess of the minimum, then the first party shall be at liberty to comply with such request.
*135 VI.
It is agreed between the parties hereto that the first party in consideration of the purchase by the second party of the properties described herein, agrees and obligates itself not to engage in competitive lumber business in Mississippi, Arkansas, Louisiana, Alabama or Tennessee, for a period of three (3) years from the date of this contract.
VII.The first party agrees to deliver possession of the real and personal property hereinbefore described on Monday, February 2, 1920, and the second party agrees*2136 to operate and maintain the same at their expense thereafter during the life of this contract, and to pay all taxes and assessments of every kind, character, and description, on both the real and personal property hereinbefore described for the year 1920.
The first party agrees to start delivery of the logs as soon as practicable after the delivery of the property as hereinbefore provided, taking into consideration the present flooded condition of the country from which said logs are to be drawn, and to continue the same agreeable to the terms of this contract.
VIII.It is agreed and understood between the parties hereto that the second party shall embrace not only the trustees herein expressly mentioned, their heirs, assigns, executors, administrators and legal representatives, but their principals and any and all parties who may be connected or associated with them in the purchase and operation of the foregoing described property, and the signing of this agreement is intended to bind each and every one to the faithful performance of this contract. This agreement shall also be binding upon the first party, its successors and assigns.
IN WITNESS WHEREOF, the parties hereto*2137 have set their hands, in duplicate, on this January 26, 1920.
R. J. DARNELL, INC.By: R. J. DARNELL, President,
First Party.
WM. PRITCHARD C. M. KELLOGG,Second Party.
Attest:
H. A. DARNELL, Secretary.
R. J. DARNELL, INCORPORATED[SEAL]
Memphis, Tenn.
Pritchard and Kellogg, and their associates at the time of the negotiations with the petitioner and the execution of the contract above set forth, contemplated the organization of a corporation to take title to the sawmill property, and such corporation, the Panola Lumber & Manufacturing Co., was thereupon organized and said contract was assigned to it by Pritchard and Kellogg. The sawmill *136 property was conveyed by the petitioner to the Panola Lumber & Manufacturing Co. by warranty deed on February 14, 1920. The purchase price of the sawmill property, as set forth in said contract, to wit, $225,000, was paid as follows: $25,000 on the signing of said contract; $50,000 upon the delivery of the deeds to the Panola Lumber & Manufacturing Co., and three promissory notes dated January 26, 1920, in the amounts of $25,000, $50,000, and $75,000, respectively, and due six months, one*2138 year, and two years from date with interest at 6 per cent, were given to the petitioner. The notes were secured by a trust deed on the sawmill property. The first note was paid at maturity, but the two other notes were renewed for a period of from six months to one year.
Delivery of logs by the petitioner to the Panola Lumber & Manufacturing Co. began in February, 1920, and by the end of the year 1922, 36,779,153 feet of logs had been delivered. By that time the timber of the petitioner had been exhausted and, although a few small additional tracts had been purchased, no more timber was available for delivery. In the year 1923 the petitioner and the Panola Lumber & Manufacturing Co. executed releases of the contract of January 26, 1920, and on February 28, 1923, the petitioner paid to the Panola Lumber & Manufacturing Co. $32,205.49, that being the amount due the latter company from the petitioner, computed at the rate of $10 per 1,000 feet on the shortage in delivery of logs, to wit, $3,220,847 feet, under the contract of January 26, 1920. The prices at which the timber was sold by the petitioner to the Panola Lumber & Manufacturing Co. were lower than the prices the petitioner*2139 could have obtained in the open market.
The depreciated cost of the petitioner's sawmill property at the date of sale was $159,721.20.
Upon the sale of the sawmill property the petitioner discontinued the manufacture of lumber. At that time it had on hand certain lumber which it continued to hold throughout the year 1920. The production cost of this lumber was $24,499.06, and the lumber was included in the closing inventory for 1920 at that amount. During the years prior to 1920 the petitioner's lumber inventories had been taken on the basis of cost of production, since cost was lower than market. The petitioner's officers intended to include said lumber in the closing inventory of 1920 at cost or market, whichever was lower.
The petitioner's invested capital for the year 1920, as determined by the respondent in the deficiency letter, should be increased by $11,088.24 on account of adjustments heretofore made in the petitioner's tax liability for the year 1918.
*137 The respondent, upon audit of the petitioner's income and profits-tax return for the year 1920, determined that the petitioner realized a profit of $65,278.80 upon the sale of a sawmill in 1920, and*2140 he included that amount in the petitioner's income for that year.
OPINION.
MARQUETTE: The first question raised herein is whether the petitioner realized any taxable gain in 1920 from the sale of its sawmill and timber and, if so, what was the amount of gain. The petitioner takes the position that it realized no gain in 1920, either from the sale of the sawmill property or the timber, for the reason that the transaction was not completed in that year, and that the profit was realized in 1923, when the contract was fully performed. The respondent contends that the petitioner realized a profit of $65,278.80 in 1920 from the sale of the sawmill, measured by the difference between the purchase price of $225,000 mentioned in the contract, and the depreciated cost of the mill at date of sale, and that the amount of $32,208.49 refunded in 1923 was a penalty for failure to deliver the minimum amount of logs provided by the contract and should not be deducted in computing the profit on the mill.
In our opinion the written instrument of January 26, 1920, was, and was intended by the parties thereto to be, a single contract for the sale of the petitioner's sawmill property and timber. *2141 The petitioner would not have sold the timber without the mill, and the Panola Lumber & Manufacturing Co. would not have purchased the mill unless it could have also purchased the timber. Without the timber, the sawmill would have had no value to the purchaser, and the sale thereof was directly dependent upon the petitioner's guarantee to furnish 40,000,000 feet of logs of certain sizes and grades, and the price paid for the mill was directly dependent on and related to the quantity of logs delivered. If 40,000,000 feet were delivered, the purchase price of the mill was to be $225,000, and the price was to be increased or diminished as the total deliveries of logs exceeded or were less than 40,000,000 feet. By the terms of the contract of January 26, 1920, the furnishing of the logs was made a part of the consideration which induced the Panola Lumber & Manufacturing Co. to purchase the sawmill. The evidence relative to the negotiations leading up to the making of the contract shows that the parties intended that the price to be paid for the mill would depend entirely upon the ability of the petitioner to deliver a certain quantity of logs, and that the adjustments to be made upon*2142 completion of delivery *138 would relate to the price of the mill and not to the logs, and that they interpreted the contract as having that meaning. It is also significant that the prices paid for the logs were lower than the petitioner could have obtained for them in the open market. Obviously, the petitioner was not entering into a separate contract to deliver logs at less than their market prie. If the sale of the mill be considered as one transaction and the sale of the logs as another transaction, with a so-called penalty for failure to deliver the minimum quantity of logs, the contract would be "one which no man in his right mind would make and no just man would enforce." We think the contract embraced and was intended to enbrace a single transaction, which was not fully completed until the year 1923. Until the contract was fully performed both as to the sawmill and the delivery of logs, it could not be ascertained whether the petitioner had realized a gain or suffered a loss from the sale of the mill and timber property. We are therefore of opinion that the profit to the petitioner from the transaction in question was not realized and could not have been determined*2143 in the year 1920. The respondent therefore erred in including in the petitioner's income for 1920 any amount as profit from this transaction.
The second question relates to the right of the petitioner now to change its closing inventory for the year 1920 from the basis of cost to market value. Section 203 of the Revenue Act of 1918 provides:
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.
On December 30, 1920, the Commissioner issued Treasury Decision 3108 which, so far as is here material, provides that:
Inventories must be valued at (a) cost or (b) cost or market * * * whichever is lower. Whichever basis is adopted must be applied consistently to the entire inventory. 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*2144 of the fact and that it represents a change is made in the return. Thereafter, changes can be made only after permission is secured from the Commissioner.
No question is raised by the petitioner as to the reasonableness or the propriety of the foregoing regulation, which the respondent promulgated under the administrative power vested in him by the statute. The question then arises, has the petitioner brought itself within the provision of the regulation? We think it has not. The regulation permits an inventory at market value if such market value is lower than cost. The petitioner has not shown to our satisfaction *139 that the 1920 market value of the lumber in question was lower than the amount at which it was included in the closing inventory. It is true that one witness, an experienced lumber man, testified that, if he had owned the lumber at the close of the year 1920, he would not have carried it on his books at more than $15,000, but that testimony is not, we think, sufficient to establish a market value. The regulation above quoted does not permit inventories based upon mere conjectures or estimates, which are all that the record herein discloses. The respondent*2145 accepted without question the inventory value furnished by the petitioner in its return, and unless and until the petitioner affirmatively shows that its inventory is entitled to another basis, we can not disturb the respondent's determination, and this the petitioner has failed to do. In view of this situation it is not necessary for us to decide whether the petitioner's application for a change of inventory was timely.
The parties hereto have stipulated that the petitioner's invested capital for the year 1920 as determined by the respondent in the deficiency letter should be increased by $11,088.24, on account of adjustment heretofore made in the petitioner's tax liability for the year 1918.
Reviewed by the Board.
Judgment will be entered under Rule 50.
MORRIS, PHILLIPS, and GREEN dissent on the first point.