*90 Decision will be entered under Rule 50.
1. Petitioner, computing its excess-profits tax credit by use of base period income, held entitled to adjustment for excessive depreciation improperly deducted during base period years.
2. Similar adjustments held proper for losses on long term contracts under N. I. R. A. improperly deducted in base period.
3. Any abnormality relating to such deductions and to others taken for unrecovered bank deposits acquired from liquidated subsidiaries, held to be a consequence of a change in petitioner's business under
*336 By this proceeding petitioner challenges respondent's determination of a deficiency in excess profits tax for the year 1941 in the amount of $ 42,347.41. The deficiency results in part from respondent's *337 action in computing petitioner's excess profits tax credit by deducting amounts for losses on contracts, losses on deposits in closed banks, and depreciation for the years 1936, 1937, and 1938. Other adjustments are not contested.
The parties have filed a stipulation of facts.
FINDINGS OF FACT.
The stipulated facts are hereby found accordingly.
Petitioner, a Michigan corporation, filed its excess profits tax return for the year 1941 with the collector of internal revenue for the district of Michigan.
Facts Relating to Losses on Contracts.
Petitioner is engaged*92 primarily in the production and sale of architectural shapes of a stock nature for store front construction and other uses. In May 1930 petitioner acquired by cash purchase all assets and inventory of the Adelbert E. Coleman Co., of Chicago, Illinois, hereinafter called Coleman, which was engaged in the production and sale of ornamental bronze products such as heavy castings made to specifications. At about the same time petitioner caused formation of the Coleman Bronze Co., hereinafter called Bronze, a Delaware corporation with an authorized capital of 5,000 shares of no par value stock. In consideration of the capital stock, petitioner transferred to Bronze all assets previously acquired from Coleman.
During the years 1930, 1931, 1932, and 1933 petitioner operated Bronze as a separate company, but formulated its policies, supplied operating capital, and paid some of its bills. On December 31, 1933, Bronze was indebted to petitioner for advances in the sum of $ 137,972.61. In consolidated Federal income tax returns for the years 1930, 1931, 1932, and 1933 petitioner and its subsidiaries reported operating losses of Bronze as follows:
| 1930 | $ 49,862.43 |
| 1931 | 46,250.45 |
| 1932 | 45,295.62 |
| 1933 | 68,880.91 |
| Total | 210,289.41 |
*93 On February 28, 1934, Bronze transferred to petitioner all of its "machinery, tools, stock equipment and contracts in process and personal property," in consideration of petitioner's surrender of the 5,000 shares of capital stock and assumption of all outstanding obligations. Petitioner desired to preserve Bronze's trade name, and for that reason delayed its complete dissolution until December 21, 1938. After February 28, 1934, petitioner operated Bronze's plant at Chicago as the *338 Coleman division of petitioner. Capital stock and income tax returns were made by Bronze for the years 1934 to 1938, inclusive, as an inactive corporation.
Among the "contracts in process" received by petitioner from Bronze were ten contracts between Bronze and prime contractors requiring Bronze to perform ornamental bronze and metal work for nine public buildings, including one Federal Reserve Bank and eight post offices. Performance had not been completed on any of those contracts by June 16, 1933, when the National Industrial Recovery Act, hereinafter called N. I. R. A., became effective. Pursuant to that act, on July 31, 1933, petitioner and Bronze each signed an agreement with the President*94 of the United States, known as the President's Re-Employment Agreement. On November 12, 1933, petitioner and Bronze became bound by the Code of Fair Competition for the Fabricated Metal Products Manufacturing and Metal Finishing and Metal Coating Industry. From and after July 31, 1933, petitioner and Bronze substantially complied with the President's Agreement and the Code of Fair Competition.
Performance of each of the above contracts resulted in a loss to petitioner. Each loss was due, in part, to increased costs brought about by the N. I. R. A. Petitioner individually, and as successor to Bronze, filed claims under the Act of June 16, 1934 (48 Stat. 974) for reimbursement on account of the increased costs incurred as a result of compliance with the N. I. R. A. In May 1936 petitioner received $ 5,184.16 in full settlement of its claim with respect to the Federal Reserve Bank building. On November 12, 1937, petitioner was notified by the Comptroller General that claims with respect to the eight post office buildings were disallowed in full. On October 11, 1938, petitioner filed a suit against the United States in the Court of Claims for recovery of the claims disallowed, and*95 on October 4, 1943, that court rendered a decision in favor of petitioner in the amount of $ 24,654.32.
The contract price and cost for each building, the losses sustained, and the amounts claimed and allowed as described above were as follows:
| Contract | Contract | ||
| Building | price | cost | Loss |
| Fed. Reserve Bk | $ 80,855.00 | $ 103,797.72 | $ 22,942.72 |
| P. O., Lansing, Mich | 9,900.00 | 11.107.68 | 1,207.68 |
| P. O., St. Paul, Minn | 190,934.75 | 222,966.90 | 32,032.15 |
| P. O., Norfolk, Va | 75,139.23 | 78,615.63 | 3,476.40 |
| P. O., Washington, D. C | 209,372.79 | 266,591.20 | 57,218.41 |
| P. O., Rochester, N. Y | 25,618.63 | 27,709.18 | 2,090.55 |
| P. O., Cincinnati, Ohio | 84,080.00 | 100,174.21 | 16,094.21 |
| P. O., Columbus, Ohio | 34,163.00 | 50,099.15 | 15,936.15 |
| P. O., Sioux City, Iowa | 52,000.00 | 62,564.83 | 10,564.83 |
| Total | 762,063.40 | 923,626.50 | 161,563.10 |
| Building | Claim | Allowed |
| Fed. Reserve Bk | $ 6,476.03 | $ 5,184.16 |
| P. O., Lansing, Mich | 912.40 | 635.43 |
| P. O., St. Paul, Minn | 12,421.51 | 6,028.21 |
| P. O., Norfolk, Va | 8,381.41 | 5,256.11 |
| P. O., Washington, D. C | 17,445.30 | 8,542.05 |
| P. O., Rochester, N. Y | 762.04 | 484.70 |
| P. O., Cincinnati, Ohio | 524.17 | 386.32 |
| P. O., Columbus, Ohio | 3.401.51 | 2,146.28 |
| P. O., Sioux City, Iowa | 1,616.85 | 1,175.12 |
| Total | 52,141.22 | 29.838.48 |
*96 *339 The reason petitioner did not file claims for the losses in full was because the applicable statute required that the losses be in "direct labor" or "direct material," and petitioner believed it would be difficult to prove itself entitled to greater amounts than those claimed.
The books and records of petitioner and its subsidiaries were kept on an accrual basis. However, in computing its income from "long-term" contracts, petitioner's books reflected no profit or loss until work under the contracts was completed. That practice was followed in the case of any installment contract extending over a period of more than one year. Each of the contracts received by petitioner from Bronze, described above, was a long term contract. Work on all those contracts had been completed by December 31, 1935.
The aggregate losses reflected in the returns of petitioner and its subsidiaries for the years 1932 to 1941, inclusive, on account of long term contracts reported on a completed contract basis, including the ten contracts for the bank and post office buildings, above, were as follows:
| 1932 | $ 555.86 |
| 1933 | None |
| 1934 | None |
| 1935 | None |
| 1936 | 22,942.72 |
| 1937 | 138,620.38 |
| 1938 | None |
| 1939 | $ 566.73 |
| 1940 | 1,591.93 |
| 1941 | 334.04 |
| Total | 164,611.66 |
*97 In its corporation income and excess profits tax returns for the years 1934 and 1935 petitioner reported net losses of $ 94,476.54 and $ 28,971.94, respectively. In the return for the year 1934 petitioner included in "cost of goods sold" the amount of $ 111,961.34 representing losses on post office contracts, as follows:
| P. O., St. Paul Minn | $ 32,032.15 |
| P. O., Norfolk, Va | 3,476.40 |
| P. O., Washington, D. C. | 57,218.41 |
| P. O., Lansing Mich | 1,207.68 |
| P. O., Columbus, Ohio | 15,936.15 |
| P. O., Rochester, N. Y. | 2,090.55 |
| Total | 111,961.34 |
In the return for the year 1935 petitioner included in "cost of goods sold" the amount of $ 22,942.72 representing the loss on the Federal Reserve Bank building contract.
In a letter to the Bureau of Internal Revenue dated June 5, 1936, petitioner's treasurer requested a ruling with respect to the proper method of reporting the losses on the above contracts. Respondent, by letter dated June 15, 1936, advised petitioner to submit more complete details. In reply petitioner's treasurer by letter dated July 2, *340 1936, gave the facts concerning the bank building contract, stating in part as follows:
Under our method of accounting for*98 large contract jobs such as this one there was no profit or loss taken on to our books until the completion of the job. On this job the contract price amounted to $ 80,855.00 and our costs were $ 103,997.72, making a loss of $ 23,142.72. Since the job was completed in 1935 this loss was reflected in our 1935 operations and was also reported for income tax purposes in the same year. At this time we had no way of telling whether we would be successful in recovering any portion of our increased costs due to N. R. A. but we did intend to file a claim therefor. This was done in February 1936, the claim being filed with Irwin and Leighton, the General Contractors, and they in turn submitted it to The Federal Reserve Bank. In May 1936 we received our final payment for the job and also received $ 5,184.16 in full settlement of our claim for increased costs due to N. R. A.
The question on which we request your enlightenment concerns the proper handling for Income tax purposes of the $ 5,184.16 recovery. * * *
In a letter to petitioner, dated December 7, 1936, respondent ruled that:
* * * since it is your consistent practice to treat your income from long-term contracts on the basis of*99 completion, the contract in question was completed in 1936 when you received the last payment thereon and in addition the sum of $ 5,184.16 in full settlement of your claim against the Government under authority of the Act of June 16, 1934, supra; that consequently no deductible loss was sustained by you on such contract in 1935; that an amended return should be filed by you for 1935 eliminating the loss deducted for such contract on your original return filed for that year; that at the time of filing the amended return payment should be made of the additional tax disclosed thereby; and that the amount of the loss on the completed contract should be determined for the year 1936 and deducted from gross income on your return covering that year.
As a result of the above correspondence, petitioner filed amended returns for the years 1934 and 1935, in which it eliminated the amounts formerly included in "cost of goods sold," above. In its returns for the years 1936 and 1937 petitioner included the following amounts in "cost of goods sold": 1936, $ 22,942.72; and 1937, $ 138,620.38. The $ 22,942.72 represented the loss on the bank building contract, and the $ 138,620.38 represented the*100 aggregate losses on the post office building contracts.
On or about December 12, 1938, operations were discontinued at the Bronze plant in Chicago. By December 31, 1939, the ornamental type business which had been carried on by Bronze was completely abandoned. Petitioner has filed a claim for relief under
In computing for the years 1940 and 1941 the excess profits tax credit based on income, petitioner, pursuant to
Facts Relating to Losses on Deposits in Closed Banks.
On April 2, 1930, petitioner acquired all the assets of Zouri Drawn Metals Co., which was engaged in the same business as petitioner, in exchange for 21,300 shares of no par value stock of the petitioner. At about the same time petitioner caused to be organized under the laws of Delaware the Zouri Co., hereinafter called Zouri, for the purpose of taking over the business and assets acquired from Zouri Drawn Metals Co., including its plant at Chicago Heights, Illinois. On or before March 10, 1932, Zouri's manufacturing facilities were moved to Niles, Michigan, but its separate trade name and trade outlets were maintained. However, its business was conducted as an integral part of petitioner's operations and no separate operating statement was made. Zouri was dissolved on February 22, 1934, and its land and buildings were sold during the year 1944.
In its Federal income tax return for the year 1938 petitioner claimed and was allowed deductions in the aggregate amount of $ 9,473.36 for *102 partial bad debts as follows:
| First State Bank | ||
| Chicago Bank of | of Chicago | |
| Commerce | Heights | |
| Original deposit | $ 11,803.54 | $ 4,586.79 |
| Less amount received | 4,188.39 | 1,376.09 |
| 7,615.15 | 3,210.70 | |
| Less estimated additional recovery | 1,123.20 | 229.29 |
| Partial bad debts | 6,491.95 | 2.981.41 |
The original deposit of $ 11,803.54 represented the balance to the credit of Bronze on June 30, 1932, in an account which was used to pay Bronze's operating expenses. Petitioner would deposit funds in that account in order to maintain a working capital for Bronze. Chicago Bank of Commerce closed on June 30, 1932. On February 28, 1934, petitioner took over that account from Bronze at its face amount.
The original deposit of $ 4,586.79 represented the balance to the credit of Zouri on December 31, 1931, in four separate accounts, three *342 being sales or collection accounts and the fourth the pay roll account of Zouri. First State Bank of Chicago Heights closed on December 31, 1931. On March 10, 1932, petitioner took over those four accounts from Zouri at their face amounts.
During the year 1938 petitioner received reports from the receivers of the above banks, as a result*103 of which it became possible to determine the amount of loss on the deposits. In addition to the deductions claimed and allowed in the year 1938, petitioner deducted losses on account of closed banks in its returns for the years 1940 and 1941 in the amounts of $ 14.92 and $ 227.22, respectively.
In computing the excess profits tax credit based on income for the year 1941, and the excess profits tax credit carry-over from the year 1940 applicable to the year 1941, pursuant to
Facts Relating to Depreciation Deduction.
In computing deductions for depreciation upon assets at its main plant at Niles, Michigan, for the years 1936 and 1937, petitioner used composite rates of depreciation which had been used at least as early as the year 1929. The same rates were used in the years 1938 and 1939. At that time petitioner's officers considered those rates correct for those *104 years.
Petitioner's returns for the years 1938 and 1939 were examined by a revenue agent, who recommended several adjustments. As a result of that examination, petitioner began an analysis and reclassification of its assets. Pending completion of that undertaking, petitioner and the revenue agent agreed upon lower rates for the years 1938, 1939, and 1940. The analysis and reclassification were completed early in the year 1942, and were used in computing rates for the 1941 return. At that time petitioner and the revenue agent agreed upon a schedule of depreciation rates, based upon the type of asset and its estimated useful life. There were no factors developed as a result of the analysis which petitioner could not have known as of December 31, 1936. The new rates as agreed upon were used by petitioner in its returns for the years 1941 to 1948, inclusive. If they had been used in computing depreciation allowable for the years 1936 and 1937, the excess profits net income for those years would have been increased by the amounts of $ 26,819.44 and $ 21,090.82, respectively.
In computing the excess profits tax credit based on income for the years 1940 and 1941, pursuant to
OPINION.
The abnormality, if any, of each of the deductions in issue, for all that the record shows, was within the meaning of
But with respect to the loss from the long term contracts under N. I. R. A. and the deductions for depreciation, it now appears that both were erroneous at the time. This is a question to be decided altogether independently of
Decision will be entered under Rule 50.