*1121 1. ACCRUAL SYSTEM OF ACCOUNTING - WHEN INCOME SHOULD BE ACCRUED. - Amounts agreed to be paid petitioner on account of the cancellation of an old contract and in consideration of further agreements made in a new contract, which amounts are to be paid out of the proceeds of refinancing the property involved in the transactions, are income to petitioner, on the accrual basis, in the year when the obligation to pay petitioner such amounts became definite and fixed. Lichtenberger-Ferguson Co. v. Welch, 54 Fed.(2d) 570; Continental Tie & Lumber Co. v. United States,286 U.S. 290">286 U.S. 290.
2. BURDEN OF PROOF. - Where the Commissioner of Internal Revenue has determined that the amounts in controversy accrued as income to petitioner in 1926, the same year in which petitioner received them, the burden of proof is on petitioner to show that such items of income accrued in a prior year. Leo M. Klein,20 B.T.A. 1057">20 B.T.A. 1057, followed.
*142 This proceeding involves a*1122 deficiency of $2,534.02 in income tax for the year 1926. The errors assigned will be stated in the opinion.
FINDINGS OF FACT.
The petitioner is a corporation, located at Cleveland, Ohio. It keeps its accounts and makes its income tax returns on an accrual basis and so kept its account and made its income tax return during the year 1924 and the years subsequent thereto.
During 1924, 1925, and 1926, petitioner was engaged in the real estate business. It owned certain realty which it had subdivided into lots and marketed to the public. In addition it acted as selling agent for various other owners of real estate subdivisions. Joseph G. Engelman was then president of the corporation.
On August 30, 1924, the East Shore Land Company, a corporation, and Joseph G. Engelman entered into an agreement with the Midland Bank, as trustee, whereby the said Engelman was given exclusive selling rights with respect to the subdivision owned by the East Shore Land Company known as The Permanent Homes Subdivision. By the terms of this agreement the said Engelman was to receive 25 per cent of the selling price of all lots sold at the time of sale, and 50 per cent of the cash proceeds of*1123 such sales when such *143 proceeds exceeded $400,000, plus certain expenditures as more particularly set forth in the agreement. Thereafter and prior to November 1, 1925, the agreement was assigned to the petitioner by Engelman.
Subsequent to the date of the agreement above referred to, and prior to November 1, 1925, it became necessary to refinance the property referred to in the agreement. The refinancing was required in order to liquidate certain mortgages that were due and payable thereon and to provide for certain improvements which were required under the terms of the agreement to be paid for from the proceeds of sales. Accordingly, negotiations for the sale of a bond issue of $600,000 to the Union Mortgage Company were entered into by the East Shore Land Company. As a condition to the issuance of such bonds, the mortgagee required that all of the cash proceeds from the sales of lots covered by such bond issue in excess of the 25 per cent commission paid to petitioner at the time of sale be applied to the liquidation of the bonds until the entire issue of $600,000 had been retired.
This requirement of the mortgagee made it impossible to carry out the terms of*1124 the agreement of August 30, 1924, above referred to, in so far as they referred to the payment of 50 per cent of the cash proceeds of the sales of lots in excess of $400,000 but not in excess of $600,000. Accordingly, a written agreement dated November 1, 1925, but executed on December 23, 1925, between the East Shore Land Company, first party, the Permanent Homes Land Company, second party, and Midland Bank, third party, and a written agreement dated December 23, 1925, between the East Shore Land Company, first party, the Union Mortgage Company, second party, and the Midland Bank, third party, were entered into. These agreements are lengthy and as it would be impracticable to incorporate them in these findings of fact they are made a part hereof by reference.
The agreement dated November 1, 1925, was an agreement between the same parties as the original agreement of August 30, 1924, substituting the petitioner for Joseph G. Engelman, as Engelman had assigned his interest in that agreement to the petitioner. This second agreement was of the same general tenor as the agreement of August 30, 1924, and by its terms terminated said prior agreement and provided for the conveyance*1125 of the unsold portions of the subdivision to the Midland Bank as trustee and for the petitioner to act as exclusive selling agent, and provided the terms of sale of the lots and the disposition of the proceeds of sale from the lots. This was all necessitated, as it recites, by the refinancing mentioned above and was only necessary because the terms of the original contract as to a division of the proceeds above $400,000 could not be carried out, due to such refinancing. In its other provisions it is essentially *144 the same as the agreement it replaced. With respect to the division of proceeds, it merely changes the base price from $400,000 to $600,000, to accord with the new financing. The division of the proceeds between $400,000 and $600,000 was provided for between the petitioner and the East Shore Land Company by a separate agreement, which was supplemented by a so-called "Disbursement Agreement," of December 23, 1925. The petitioner is not a party to this "Disbursement Agreement," although its approval was noted on the agreement in writing in the following language: "Examined and approved: The Permanent Homes Land Company. By Joseph G. Engelman, President." This*1126 is an agreement between the parties to the bond issue and provides for the disbursing of the proceeds of such sale. On this subject the agreement contains the following:
(3) All sums credited to First Party hereunder, shall be used and applied by Second Party, as follows:
* * *
(e) To the Permanent Homes Land Company, the sum of $36,789.36.
The "Disbursement Agreement" also contains a clause reading as follows:
(5) It is understood and agreed that Second Party shall not be required to accept any of said bonds or to credit First Party with the purchase price thereof, as aforesaid, until all legal proceedings in connection with said bonds have been approved in writing by Messrs. Mekin, Cross and Daanst on its behalf.
On the same date, i.e., December 23, 1925, a mortgage and collateral trust agreement was entered into between the East Shore Land Company, first party, and the Midland Bank, as trustee, second party. For convenience, this agreement was dated as of November 1, 1925. It provided for the issuance of bonds by the first party in the amount of $600,000 upon the security of the property which was covered by the agreement dated August 30, 1924. These bonds were*1127 sold to the Union Mortgage Company, as authorized in Article III of the agreement herein referred to.
This agreement, among other things, recites that the East Shore Land Company approved the issuance of the bonds on December 22, 1925, and directed their delivery to the trustee. It also provides the terms and conditions and form of the bonds, and recites the properties securing the same. Among such properties the land contracts then existing are included. The trust deed contains the following proviso in section 3 of Article III: "The company having deducted from the sale price of each sublot the commission for the sale of the same, no part of the money collected by the trustee as aforesaid shall be applicable to the payment of commissions." In section 4 of Article III it is provided that on any defaulted contracts the property shall be resold, without deduction for commissions.
*145 Pursuant to these agreements the sum of $37,285.25 was paid to the Permanent Homes Land Company in February, 1926, by the Union Mortgage Company and the East Shore Land Company.
The amount of $37,285.25 paid to the petitioner in 1926 as aforesaid was the amount which the parties to the*1128 agreement determined should be paid petitioner in lieu of additional commissions on sales of lots between a total of $400,000 and $600,000, as provided for in Article VIII of the agreement of August 30, 1924, of which it was deprived due to the provisions of the agreement of November 1, 1925, and the mortgage and collateral trust agreement of the same date, which agreements required, among other things, that the proceeds of all sales of lots should be paid to the trustee for the bond issue until such bond issue was retired. The amount of $37,285.25 so paid was computed as follows:
Amount to accrue to Permanent Homes Land Company when proceeds of sales exceed $400,000, but are not in excess of $600,000 --- $100,000.00
Less 50% of expense accrued:
| Interest on $400,000 | $2,606.28 | |
| Trustee expense | 8,483.13 | |
| Miscellaneous expense | 250.00 | |
| Attorney's fees | 1,590.00 | |
| Interest on bonds | 12,500.00 | |
| Additional improvements | 60,000.00 | |
| 85,429.41 | 42,714.75 | |
| 57,285.25 | ||
| Less share of bond discount | 20,000.00 | |
| 37,285.25 |
The amount specified to be paid petitioner by paragraph 3(e), page 3, of the agreement is $36,789.36. This sum was increased to $37,285.25*1129 by adjustment of the items of interest and expenses which entered into the computation set out above.
At December 31, 1926, the net proceeds of sales of lots in the Permanent Homes Subdivision had not exceeded $400,000, but aggregated $233,270.01.
The bond discount referred to above is on the bonds provided for by the terms of the mortgage and collateral trust agreement of November 1, 1925.
*146 On the journal entries of the petitioner, the payment of $37,285.25 was treated as follows:
| Dr. | Cr. | |
| February 28, 1926. | ||
| Cash from Midland Bank | $527.11 | |
| Dividends from East Shore Land Co | $527.11 | |
| February 19, 1926. | ||
| Cash from Midland Bank | $36,758.14 | |
| Dividends from East Shore Land Co | $36,758.14 | |
| December 31, 1926. | ||
| Dividends from East Shore Land Co | $37,285.25 | |
| Advance on contract | $37,285.25 |
Corresponding entries on the books of the East Shore Land Company were made in an account carried as "Deferred Commission Account" as follows:
| 1926 | ||
| Feb. 28 | Cash from Midland Bank | $527.11 |
| 19 | Disbursement of Permanent Homes Land Company's share of proceeds of bond issue they received $56,758.13 less $20,000.00 | $36,758.13 |
| Share of discount | 20,000.00 |
*1130 OPINION.
BLACK: The question we have to decide in this proceeding is whether items of income aggregating $37,285.25 accrued to petitioner in 1926 so as to make them taxable for that year.
For the year 1924 and subsequent years, petitioner kept its accounts and made its income tax returns on the accrual basis. Petitioner contends, in the first place, that the items constituting the $37,285.25 were paid to it in 1926 as advance commissions, and that these commissions were not earned in 1926 and could not be earned until subsequent years and hence could not be properly accrued as income on petitioner's books in 1926 and were not taxable in 1926. Petitioner further contends, in the alternative, that, if it is wrong in the foregoing contention, then the items of income aggregating $37,285.25 are taxable to it in 1925, because it was in that year that its unequivocal right to receive such sums of money was fixed.
Respondent's contention is that the sums in question were received by the petitioner during the year 1926 in consideration for the cancellation of the agreement of August 30, 1924, and as such is taxable income in the year in which received. Respondent also contends*1131 that nothing accrued to petitioner in 1925 on account of these several contracts *147 mentioned in our findings of fact. We will discuss these respective contentions in their order.
Petitioner, in support of its first contention, cites the following statement approved by the Commissioner (Law Opinion 1086, C.B.I. 1, p. 87):
In order to be accruable in the taxable year for which return is made, a valid right to income must have arisen or existed in that year, which is enforceable on the date the income is due. If, however, the right to the amount is contingent upon the happening of some future event, there is no certainty that it will be paid or will accrue. In this event no income accrues from a fixed and determinable source, and no right to anything arises or exists in the taxable year which can be accounted for as income under any system of accounting.
So say we. This rule was recently approved in substance by the court in . In that case the court held that a taxpayer can not, under the accrual system, accrue items of income or items of expense which are uncertain in receipt. Says the*1132 court: "A mere contingent claim * * * may never be sustained or realized. It is too uncertain in making up income tax returns." But, suppose that, before the taxpayer's contingent right to receive the income under the original contract has become fixed, the contract itself is altered and modified and it is agreed that he shall receive a sum certain, without regard to the contingent provisions of the former contract. What then? Is he to be permitted to carry such income on his books in suspense after his right to receive it has become fixed and after he does actually receive the money? We think not. Petitioner cites many authorities in support of its main contention, all of which we have carefully considered, but none of which we think are in point.
We see no gain in taking up these cited authorities and pointing out one by one why we do not think they are applicable to the facts in the instant case.
Undoubtedly, under the original contract which petitioner had with the East Shore Land Company, the only amount which it was entitled to accrue as a profit when it made a sale of lots was the 25 per cent commission which was to be paid it in the first instance when lots were*1133 sold. The additional agency commission or division of profits, whichever it may be called, which it was to receive after total sales had aggregated $400,000 was purely contingent upon sales reaching that point; and, unless and until total sales did aggregate $400,000, there was nothing for petitioner to accrue on its books as income on account of this particular clause of the contract.
But this original contract was terminated in 1925, by mutual agreement, on account of the need for refinancing the property which was being sold, and a new contract was entered into, carrying many of *148 the same provisions of the old contract and modifying and changing others. As an upshot of this new contract and the terminating of the old, it was determined and agreed in 1925 that petitioner, subject to certain conditions, should receive $36,789.36 of the proceeds of the new financing. Just what this was for is not made very clear by the evidence. Petitioner did not actually receive this amount until February 19, 1926, but, as we shall endeavor to point out, that makes no difference if petitioner's right to receive it became definite and unqualified in the year 1925.
*1134 In , the court held that when the amount of compensation due the taxpayer from the Government on account of the cancellation of a war contract was definitely approved in August, 1919, it represented income on the accrual basis for 1919, even though payment of the claim was delayed until February, 1920. "Under the accrual system of accounting," said the court, "when an item is definitely ascertained as to its amount and acknowledged to be due, it has accrued." The court quotes from our opinion in , as follows: "Under an accrual system of accounting, one accrues income and does not receive it. Under the receipts and disbursements basis method, one receives income and does not accrue it."
To the same effect is the recent decision of the Supreme Court in . It does not matter that the taxpayer, as appears to be the case in the instant case, did not take the item into its accounting until 1926, if the income actually accrued in 1925, for, as we said in *1135 , "Bookkeeping entries are significant only as evidence or records of transactions and the legal effect of such transactions and the method employed in keeping books must be determined from the transactions themselves, and not merely from the book entries affecting them." So we hold that petitioner's contention, that this income in question can be held in suspense and rendered for taxation in some future year or years when the aggregate of sales has reached a certain named amount, is untenable. We find no support for such a theory either in the statutes or the decided cases.
Petitioner also contends in its brief that this $36,789.36 was not income in either 1925 or 1926, because it was a loan. We see no merit in that contention. Certainly, if the evidence showed that this $36,789.36 represented money which petitioner borrowed for use in its business, we would not hold that it represented income. Borrowed money does not represent income. But there is no evidence whatever that this sum represented money which petitioner had borrowed. To whom was the petitioner obligated to repay? No one. The money was borrowed by the East Shore*1136 Land Company *149 in the sale of its bonds and for which it was primarily liable. Petitioner was in no way obligated for the repayment of this loan or any part of it. So, whether the $36,789.36 is regarded as advance commissions, as petitioner primarily contends, or represents a sum received in payment for the cancellation of a contract, as respondent contends, it is income.
The only question is whether petitioner's right to receive this amount accrued in the prior year of 1925, or accrued in 1926, the same year in which it was paid. If the latter event is true, respondent is correct in taxing it in 1926. If, however, petitioner's right to receive this $36,789.36 became definite and fixed in 1925, then, under the authorities we have already cited, it is income for 1925 and not for 1926. There can be no question but that the amount which petitioner was to receive as a result of these refinancing transactions if and when they were completed, was definitely fixed in 1925 to the extent of $36,789.36.
But it is not enough that the parties definitely agree upon the amount. In order for it to be a proper accrual item of income, the obligation to pay the amount fixed must*1137 be definite and unequivocal. A promise to pay, if and when certain contingencies take place, is not sufficient to make an item accruable. And herein lies the defect in petitioner's alternative contention that it should be permitted to accrue this item as income in 1925.
It was agreed that the sum accorded to petitioner in the so-called disbursement agreement was to be paid out of the proceeds of the bond issue, and, if the bond issue failed to go through, there was no obligation to pay petitioner anything. This fact is shown by clause (5) of the "Disbursement Agreement" copied in our findings of fact.
Was this bond issue completed in 1925? We doubt it. The so-called disbursement agreement was dated December 23, 1925, and only a short time remained in that particular year to complete the bond issue. It is more reasonable to suppose that the approval of the legal matters connected with the bond issue by the attorneys and the completion of the sale of the bonds did not take place until in 1926. It was in that year, on February 16, that petitioner received the $37,285.25 in question. But at any rate we can not decide cases on uncertainties and suppositions. We must decide*1138 them on facts. The facts are that respondent in his determination of the deficiency has determined that this $37,285.25 was not only received by petitioner in 1926, but that it was income which accrued to petitioner in that year and in no other. When the Commissioner has determined that income accrued in a certain year, the burden is on the taxpayer to prove otherwise. .
*150 The stipulation contains the following clause: "These bonds were sold to the Union Mortgage Company as authorized in Article III of the agreement herein referred to as Exhibit "B" and as stated in the agreement herein referred to as Exhibit "C"." If this sale was completed in 1925, the stipulation should so state. We have no evidence which will justify us in holding that the bond transaction was completed in 1925. Until the attorneys had approved the legality of all the matters connected with the bond issue, there was no obligation on the part of the Union Mortgage Company to take the bonds and to credit the East Shore Land Company with the proceeds thereof and to pay petitioner the amount it was to receive. So far as the evidence we have before us shows, *1139 the obligation to pay petitioner the agreed sum was purely contingent in 1925.
Reviewed by the Board.
Decision will be entered for respondent.