*963 Held, that the manner in which the petitioner claimed and was allowed a deduction for Federal income taxes was not misrepresentation of a material fact upon which a closing agreement, entered into pursuant to section 606 of the Revenue Act of 1928, might be disregarded for the purpose of imposing additional income tax liability for the taxable period covered by the agreement.
*291 This proceeding was instituted for the redetermination of a deficiency of $18,125 in income tax for 1926. The issues are (a) whether a closing agreement entered into respecting income tax liability of the petitioner and its subsidiaries for 1926, pursuant to the provisions of section 606 of the Revenue Act of 1928, may be disregarded for the purpose of determining additional income tax liability, and if so, (b) whether the amount improperly claimed by the petitioner, and allowed by the respondent, as a deduction for Federal income taxes, is $145,000 as determined by the respondent, or $71,000 as claimed by the petitioner.
FINDINGS OF FACT.
The petitioner, a fire*964 insurance company incorporated under the laws of the State of Connecticut, on behalf of itself and the Connecticut Fire Insurance Co., the Equitable Fire & Marine Insurance Co., and the Phonix Securities Co., filed a consolidated return for 1926, disclosing income tax liability of $108,482.54.
The return contained a deduction for "Taxes" of $1,149,496.12. The manner in which the deduction was computed was shown in *292 Schedule 5, attached to the return, reading, excluding the figures making up the totals, as follows:
| Year Ended December 31, 1926. | |
| Taxes, Schedule E. | |
| Total | |
| Taxes, Licenses and Fees: | |
| Federal | $104,159.19 |
| State, County and Municipal | 506,561.74 |
| Insurance Department | 77,157.48 |
| Fire Department | 60,806.99 |
| Fire Patrol and Salvage Corps | 39,957.48 |
| Real Estate | 8,440.36 |
| Stockholders (Connecticut) | 269,339.50 |
| All other Taxes | 18,401.38 |
| Accrued December 31, 1926 | 900,000.00 |
| $1,984,824.12 | |
| Less Accrued December 31, 1925 | 724,000.00 |
| $1,260,824.12 | |
| Deduct: | |
| Federal Income Taxes | 103,831.29 |
| Income Taxes paid to Foreign Countries and to Possessions of the U.S. | 7,496.71 |
| $1,149,496.12 |
The petitioner filed with the consolidated*965 return copies of annual statements rendered by it and its subsidiaries, except the Phoenix Securities Co., to the insurance departments of their respective states of incorporation for 1926 on the statement form approved by the National Convention of Insurance Commissioners. There were listed in the reports, hereinafter referred to as the "annual statements", as liabilities under the heading "Estimated amount hereafter payable for Federal, State and other taxes based upon the business of the year of this Statement", amounts aggregating $900,000. Of this amount and the corresponding sum catalogued in schedule 5, $145,000 represented estimated Federal income tax liability of the petitioner and its subsidiaries, except the Phoenix Securities Co., for 1926. The amount of $724,000 deducted in schedule 5 for taxes accrued December 31, 1925, included the sum of $74,000 as an estimate of the Federal income tax liability of the petitioner and its subsidiaries for 1925. The net amount deducted in the return for Federal income taxes accrued December 31, 1926, was $71,000.
The petitioner's secretary supervised the preparation of the annual statements in detail. The consolidated return was*966 prepared by a so-called "tax expert" under the general supervision of the secretary *293 of the petitioner. The annual statements make no provision for the itemization of the total amount to be shown as a liability under the heading "Estimated amount hereafter payable for Federal, State and other taxes based upon the business of the year of this Statement." The petitioner's secretary, who signed the consolidated return as such, was aware that schedule 5 contained an item for Federal taxes accrued December 31, 1926, but at the time the return was filed he did not realize that the amount included a sum for Federal income taxes.
Thereafter, in due course, the return was examined in the Bureau of Internal Revenue in Washington by an employee of the respondent who audited most of the consolidated returns filed by insurance companies. The basis for the audit was the return and the statements and schedules attached thereto, including the annual statements. At that time it was not customary to make field examinations in connection with the audit of returns of insurance companies except in unusual cases, such as where a claim for a large amount was filed or where the adjustment*967 of a large sum was involved, and the Bureau of Internal Revenue could not obtain the desired information through correspondence. The employee of the respondent who audited the return was aware during the course of the audit that the annual statements listed amounts aggregating $900,000 as liabilities for Federal, state and other taxes. He made no inquiry, however, as to the kind of Federal taxes included in the amount.
On July 28, 1928, during the course of the audit made by the respondent of the return, a letter was addressed to the petitioner requesting a statement showing the amount of Federal income taxes refunded to the petitioner or credited to its account in 1926. The petitioner answered the communication under date of August 3, 1928.
On September 4, 1928, the respondent sent a 30-day letter to the petitioner proposing a deficiency of $13,327.19 in income tax for 1926, and requesting that it file a report on Form 1118, showing all income, war profits and excess profits taxes paid or accrued during the taxable year to a foreign country or to a possession of the United States. The additional tax resulted from adjustments made in the amount of losses claimed to have been*968 sustained. The report requested by the respondent was transmitted to him with a letter dated October 2, 1928. Other correspondence was had with reference to the basis for the additional tax and the credit claimed for taxes paid to foreign countries. Thereafter, based upon the data furnished by the petitioner, the income tax liability of the petitioner and its subsidiaries for 1926 was reduced to $109,716.27, resulting in a deficiency of $1,233.73, which amount the petitioner paid December 22, 1928.
*294 On March 7, 1929, the petitioner and its subsidiaries and the respondent entered into an agreement pursuant to the provisions of section 606 of the Revenue Act of 1928. The agreement contains the following provision:
NOW, THIS AGREEMENT WITNESSETH, that said taxpayers and said Commissioner of Internal Revenue hereby mutually agree that the principal amount of such liability so determined shall be final and conclusive if and when this agreement is approved by the Secretary of the Treasury or the Undersecretary.
The amount of income tax liability for 1926 shown in the agreement was $109,716.27. The agreement was approved by the Secretary of the Treasury March 23, 1929.
*969 After the execution of the closing agreement the respondent made a field audit of petitioner's return for 1927 and determined that the amount of $145,000 had been deducted in the consolidated return for 1926 for Federal income taxes accrued December 31, 1926. Thereafter the respondent increased the taxable net income of the consolidated group by $145,000, resulting in the deficiency in income tax giving rise to this proceeding. On August 2, 1930, the respondent eliminated the petitioner's name from the schedule of cases listed as settled by closing agreements.
OPINION.
SEAWELL: The closing agreement executed on March 7, 1929, relating to the total income tax liability of the petitioner and its subsidiaries for 1926, was entered into pursuant to section 606 of the Revenue Act of 1928, which reads as follows:
(a) Authorization. - The Commissioner (or any officer or employee of the Bureau of Internal Revenue, including the field service, authorized in writing by the Commissioner) is authorized to enter into an agreement in writing with any person relating to the liability of such person (or of the person or estate for whom he acts) in respect of any internal revenue tax*970 for any taxable period ending prior to the date of the agreement.
(b) Finality of agreements. - If such agreement is approved by the Secretary, or the Undersecretary, within such time as may be stated in such agreement, or later agreed to, such agreement shall be final and conclusive, and, except upon a showing of fraud or malfeasance, or misrepresentation of a material fact -
(1) the case shall not be reopened as to the matters agreed upon or the agreement modified, by any officer, employee, or agent of the United States, and
(2) in any suit, action, or proceeding, such agreement, or any determination, assessment, collection, payment, abatement, refund, or credit made in accordance therewith, shall not be annulled, modified, set aside, or disregarded.
* * *
The *295 language of section 606 clearly evidences an intention on the part of Congress that cases closed by agreements executed under its terms should be held to settle for all time the tax liability agreed upon, in this case the total income tax of the petitioner and its subsidiaries for 1926, except upon a showing of fraud or malfeasance, or misrepresentation of a material fact.
In this proceeding no*971 claim is made of fraud or malfeasance. The respondent does contend, however, that the agreement should be set aside for the determination of a deficiency for 1926 because of misrepresentation of a material fact. The basis for his claim is that schedule 5, which was attached to the consolidated return to support the deduction of $1,149,496.12 taken in the return for "Taxes", was prepared in such a manner as to make it appear that the amount deducted was exclusive of Federal income taxes. The importance of the question is due to the fact that Federal income taxes paid or accrued within the taxable year are not deductible from gross income. Secs. 247(a)(3) and 234(a)(3), Revenue Act of 1926. The petitioner's position is that the respondent's error in allowing the full amount claimed as a deduction for taxes, without first eliminating therefrom an amount erroneously included by the petitioner for Federal income taxes, was due to a mistake of fact, not misrepresentation by it of a material fact.
The decision turns almost entirely upon whether schedule 5, when read in connection with the annual statements, misrepresented the material fact that the net amount of $1,149,496.12 deducted*972 included a sum for Federal income taxes.
We shall first decide whether the inclusion of $145,000 for Federal income taxes in the amount of $900,000 accrued for all taxes at December 31, 1926, was a misrepresentation of a fact.
The facts of schedule 5, briefly stated, are these. The petitioner first listed, under the subject of taxes, licenses and fees, amounts aggregating $1,084,824.12, including $104,159.19 for "Federal taxes" paid by each of the corporations during the year, and then the sum of $900,000 for taxes, licenses and fees accrued at December 31, 1926. Of the amount of $900,000, $145,000 represented an accural for Federal income taxes. From the total of $1,984,824.12 for taxes, licenses and fees paid during the year and accrued at the end of the year, the petitioner deducted the amount of $724,000 accrued December 31, 1925; $103,831.29 for Federal income taxes paid during the year and $7,496.71 for income taxes paid to foreign countries and possessions of the United States. The petitioner claimed the remainder of $1,149,496.12 in the consolidated return as an expense deduction for taxes and the respondent allowed the deduction in determining the income tax liability*973 of the petitioner and its subsidiaries *296 for 1926 to be $109,716.27, as set forth in the closing agreement.
The return was examined by an auditor of the respondent experienced in income tax matters relating to insurance companies, and the papers which were filed with the return were before him when he made his audit. He testified that he was aware that the item of $900,000 appearing in schedule 5 agreed in amount with the aggregate of the amounts shown in the annual statements as liabilities for "Estimated amount hereafter payable for Federal, State and other taxes based upon the year of this Statement," and that he made no inquiry to ascertain the nature of the Federal taxes, the amounts of which were represented by the figure. No claim is made by the respondent and it does not appear from the record that the auditor ever believed that the entries represented different liabilities or accruals.
When read without reference to the annual statements, the purport of the entry of $900,000 in schedule 5 is not entirely clear. We think, however, that it is sufficiently explained by the corresponding entries in the annual statements to convey the idea that it included Federal*974 income taxes. The term "Federal taxes" embraces income taxes imposed by the United States. The return filed by the petitioner for 1926 showed a tax liability of $108,482.54, all or the greater part of which the respondent must or should have known was included in the annual statements as Federal, state and other taxes, in view of the fact that the approved form of annual statements made provision for showing all liabilities and did not call for an itemization of accruals for taxes. This, we think, was direct notice to the respondent that the accrual of $900,000 included an estimated amount for Federal income taxes. Certainly it is not representation that it was exclusive of such taxes, and we so hold.
The respondent points to the deduction of $103,831.29 made in schedule 5 for Federal income taxes paid within the year as representing an elimination of all of such taxes, paid and accrued, from the statement.
The initial explanatory note for the deduction, reading "Deduct Federal Income Taxes," does not represent that the sum actually included an amount for accrued taxes. All of the figures making up the total were in dollars and cents and closely approximated the amounts*975 listed in the annual statements as having been paid during 1926 for "Federal taxes," the difference being but $327.90, including the sum of $153.90 paid by the Phoenix Securities Co., which was a holding company and apparently did not file an annual statement. The auditor who examined the return was fully aware of this slight difference between the two figures and believed, without making an investigation to sustain his opinion, that it represented *297 "stamp taxes or some miscellaneous minor Federal taxes, not income taxes." He further testified that he thought the deduction represented taxes paid for 1925 together "with any probable addition to the reserve for the current year, 1926." There appears to be no justification for such a conclusion in the light of the fact that the consolidated return for 1926 showed an income tax liability of $108,482.54, all or most of which respondent should have known was included in the annual statements as an accrual for 1926 Federal taxes.
As we view the evidence the petitioner unintentionally neglected to eliminate all Federal income taxes from the statement and the respondent failed to detect the error in his examination of the return, *976 with the result that the petitioner received an unauthorized deduction from its income. There was no misrepresentation on the part of the petitioner as to how the deduction was accomplished. All of the facts were before the respondent and we think a fair interpretation of them is that the entry of $103,831.29 does not purport to eliminate any amount previously included as an accrual for Federal income taxes for 1926, but merely excludes amounts paid within the year for such taxes.
In our opinion there has been no showing of misrepresentation of a material fact, and, accordingly, the closing agreement entered into respecting the income tax liability of the petitioner and its subsidiaries for 1926 may not be disregarded by the respondent.
Having reached such a conclusion, it is unnecessary for us to set forth our reasons for finding as a fact that the amount of Federal income taxes claimed by the petitioner and allowed by the respondent for 1926 was $71,000.
Reviewed by the Board.
Decision will be entered for the petitioner.
SMITH, TRAMMELL, and MURDOCK concur in the result.
ADAMS dissents.