*3894 1. Prior to the taxable year in question merchandise belonging to the petitioner's customers was destroyed by fire in the petitioner's plant and a contract between the customers and the petitioner was executed providing a means of payment to the customers and the avoidance of possible litigation by the petitioner. Payments and allowances made under such contract during the taxable year held not a deductible expense in that year.
2. Special assessment denied.
3. Penalty for delinquency approved.
*1360 This proceeding arises from a determination by the Commissioner of a deficiency in income and profits taxes for the fiscal year ended May 31, 1919, in the amount of $22,060.34, consisting of taxes, $17,648.27, and a penalty for delinquency, $4,412.07; the Commissioner having disallowed a deduction claimed by the petitioner in the sum of $38,541.85, now alleged to be $29,631.32, and having asserted a 25 per cent penalty for delinquency, and having denied the petitioner's claim for special assessment.
Three issues are involved:
*3895 (1) Whether the petitioner is entitled to deduct, in computing its net income for the fiscal year ended May 31, 1919, an item of $29,631.32, alleged to represent allowances made to certain of the petitioner's customers in that year arising out of the destruction by fire in the previous year of certain goods bailed to petitioner by these customers;
(2) Whether the petitioner is entitled to relief under the provisions of section 328, Revenue Act of 1918; and
(3) Whether the penalty for delinquency was properly asserted against the petitioner by reason of its failure to file its return within the time prescribed.
FINDINGS OF FACT.
1. The petitioner is a New Jersey corporation with its principal office at 168 East 5th Street, Paterson, N.J., organized in 1917, and engaged in the business of dyeing and finishing. In January, 1918, petitioner held at its plant awaiting dyeing a quantity of raw silk goods belonging to its various customers. These goods while so held were, on January 21, 1918, either wholly destroyed or badly damaged *1361 by fire. The approximate extent of the damage was $85,000. The customers, with the exception of two firms, Altman & Grodin and Hermann*3896 Feuer, carried no insurance on their goods. The petitioner carried approximately $40,000 insurance on its machinery, fixtures, and chemical supplies, and the goods bailed to it by customers for the purpose of dyeing. At the time of the fire a more than usually large stock of raw silks was stored in petitioner's stock room. Before the time of the fire petitioner made no contracts with its customers relating to insurance and did not hold itself out as an insurer on its business letterhead. The contracts for receiving and dyeing raw silks consisted of parol agreements of petitioner to receive and dye goods at a certain price.
The petitioner, wishing to remain in business, and believing this end could best be accomplished through the retention of its old customers, entered into an agreement on February 5, 1918, with all these who had suffered loss by fire, as follows:
AGREEMENT made this fifth day of February, Nineteen Hundred and Eighteen, between the EAGLE PIECE DYE WORKS, a Corporation of the state of New Jersey, having its principal office in the City of Paterson, County of Passaic and State of New Jersey, of the first part, and [petitioner's customers, parties of the second*3897 part]
WITNESSETH:
WHEREAS the party of the first part has been and now is engaged in the business of dyeing and finishing silk for manufacturers and others, and has lately suffered loss and damage by fire, and
WHEREAS each of the said [parties of the second part] have suffered losses and damages by reason of silk, belonging to them respectively, having been damaged and destroyed by fire while in the premises of said party of the first part, and
WHEREAS it appears that upon an adjustment of the insurance carried by the party of the first part upon the silk entrusted to it, that each of the parties of the second part hereto shall suffer a loss by reason of their having entrusted silk to said party of the first part for the purpose of being dyed and finished and their failure to cover said silk to the extent of the value thereof by insurance, and
WHEREAS the party of the first part is continuing its business and will continue to dye and finish silk for manufacturers and others as before and intends to provide a means by which the losses of the parties of the second part may be recouped and recovered and made up.
NOW THEREFORE, it is agreed that all moneys payable upon, *3898 for and from insurance upon silk entrusted to the party of the first part by parties of the second part shall be assigned to Henry H. Parmelee in trust for parties of the second part.
2. That all insurance moneys payable upon, for and from the insurance upon machinery, machines and other property of party of the first part, excepting, however, such insurance as shall be specifically payable to Van Vlaanderen Machine Company, shall be forthwith assigned and made payable to Henry H. Parmelee in trust for parties of the second part.
*1362 3. All moneys payable upon, for and from insurance upon silk or other property of party of the first part, shall be forthwith assigned to Henry H. Parmelee in trust for the benefit of parties of the second part and the purposes herein set forth and all salvage of any and every kind including machinery equipment, shall as soon as same shall be determined, be assigned, conveyed, transferred and set forth unto Henry H. Parmelee in trust for parties of the second part and for the purposes thereof.
4. The business of the party of the first part is to be continued by it, but no new equipment is to be purchased and no indebtedness, other*3899 than that absolutely necessary for the conduct of said business, shall be incurred unless, in the judgment of Henry H. Parmelee and the Committee herein stated, the party of the first part should acquire such equipment or incur such indebtedness.
5. It is understood that certain insurance covering upon machinery and machines and other equipment of party of the first part is payable to Van Vlaanderen Machine Co., and that nothing herein is intended to interfere with the rights of said Van Vlaanderen Machine Co., and also that out of the moneys received from the insurance upon machinery and other equipment and property of party of the first part, there is to be used such part thereof as may be necessary for restoring, repairing and replacing such machinery, equipment and other property as is necessary to continue the business of the party of the first part.
6. All moneys received from insurance and available for the purpose hereinafter set forth shall be used as follows:
(a) to pay to the persons who have suffered loss by reason of their having entrusted silk to party of the first part to be dyed, finished and otherwise worked at least one-third (1/3) of their respective losses.
*3900 (b) to pay any and all sums of money which may be borrowed or which may be advanced to party of the first part by any bank or person for the purpose of continuing the business of the party of the first part.
(c) to bear, pay and satisfy the proper costs and expenses herein, including attorneys' fees.
7. In determining the loss suffered by each of the parties of the second part hereto, it is agreed that each of said parties of the second part shall file a verified statement of his or its loss and that said loss shall be based upon the actual net cost of the goods to the person suffering loss who are now indebted to the Eagle Piece Dye Works shall give credit to said Eagle Piece Dye Works on account of their loss for any moneys owing or credits, or allowances to which Eagle Piece Dye Works may be entitled. All claims are to be filed with Jacob Kushner, Esquire, as attorney for the parties of the second part and Husdon & Joelson, Esquires, attorneys for Eagle Piece Dye Works.
8. In determining the loss of the parties of the second part hereto, allowance shall also be made to Eagle Piece Dye Works for any insurance recovered by any of the parties of the second part upon*3901 insurance carried by them covering upon any silk entrusted to party of the first part.
9. Upon payment of at least one-third (1/3) of the respective losses of the parties of the second part, if made as aforesaid, party of the first part shall make, execute and deliver to each of the parties of the second part hereto its note, payable in six months non-negotiable, however, and renewable in periods of six months; said notes to be for such sums as shall then be owing to parties of the second part respectively and to bear interest. The said notes shall be reduced at each maturity thereof to the extent of the profits of the business of Eagle Piece Dye Works, so far as the committee herein named and the trustee shall determine.
*1363 10. All of said notes shall be endorsed individually by Joseph Platt, Edmond H. Reynier and Jean A. Pinatel and all renewals of said notes shall be likewise endorsed. Said notes are endorsed, however, and are accepted by said parties of the second part on the distinct and positive understanding that the liability of each of the said Joseph Platt, Edmond H. Reynier and Jean A. Pinatel, shall in no event exceed one-third (1/3) of the amount of*3902 said notes; notwithstanding their said endorsement of the whole amount secured by said notes. The purposes hereof being to secure to the parties of the second part payment of any moneys which may be due them to Eagle Piece Dye Works as aforesaid subject to limitation of the individual responsibility of said Joseph Platt, Edmond H. Reynier and Jean A. Pinatel.
11. Each of the parties of the second part hereto hereby severally agree and in consideration of the promises and of the undertaking by party of the first part, promises to each other not to sue, bring suit or commence action of any kind against Eagle Piece Dye Works, Joseph Platt, Edmond H. Reynier, Jean A. Pinatel or any of them, for or by reason of the loss sustained by the parties of the second part respectively on account of the destruction of property of parties of the second part by said fire.
12. The parties of the second part hereto hereby select as a Committee to represent them in all matters herein the following: Jacob Kaltz, Clements Hellman, and Joseph Koransky, and hereby authorize and empower and agree to abide by, ratify and confirm all acts and things done by said Committee.
13. It is agreed that*3903 the parties of the second part hereto with the consent of party of the first part select and appoint Henry H. Parmelee as trustee, and authorize the said Henry H. Parmelee to do any and all acts and things which may be necessary to be done in the conduct of the business of party of the first part.
14. It is agreed that during the time the Eagle Piece Dye Works is indebted to parties of the second part hereto, or any of them, it shall make no payments out of its corporate funds except by checks, notes or drafts which shall be countersigned by its trustee, Henry H. Parmelee.
15. It is agreed that during the time party of the first part is indebted to parties of the second part or any of them that said Joseph Platt, Edmond H. Reynier and Jean A. Pinatel, shall draw from said business no moneys in excess of their weekly wages which are hereby fixed at fifty $50.00.
16. Parties of the second part hereto and hereby expressly authorize and empower any person or persons to loan to said party of the first part any sum or sums of money not exceeding however, 3 Thousand Dollars to be used in payment of the indebtedness of the Eagle Piece Dye Works in meeting its operating expenses.
*3904 17. The parties of the second part hereto and hereby expressly covenent, promise and agree that any moneys so as aforesaid loaned and advanced to Eagle Piece Dye Works shall be lien upon and against in and of insurance moneys payable to Eagle Piece Dye Works upon, for and by reason of the destruction, or loss, or damage to any of the goods of parties of the second part.
18. The parties of the second part hereby assign, transfer and set over unto the person, or corporation loaning or advancing, the said insurance and all moneys payable thereon for the purpose of securing and paying to such person or corporation any and all moneys loaned and advanced to Eagle Piece Dye Works as aforesaid and said parties of the second part hereby authorize and empower said person or corporation loaning or advancing moneys as aforesaid, *1364 to take any and all measures and proceedings necessary to secure the repayment and recovery of the moneys so loaned and advanced. $19. The party of the first part and the parties of the second part expressly agree to and with Henry H. Parmelee that they hereby ratify and confirm any and all acts, matters and things by him done, transacted, carried*3905 on, or to be done, performed and carried on and deemed by him, the said Henry H. Parmelee, to be necessary or expedient for the purpose of carrying out the provisions of the foregoing agreement and agree to abide by, stand by, ratify and perform any and all such acts, matters and things and to save the said Henry H. Parmelee harmless absolutely from and by reason of any act, matter and thing by him done, performed, entered into or carried on, on account of the subject matter of the foregoing agreement, or any act, matter or thing which the said Henry H. Parmelee may consider should be done, performed, entered into or carried on by reason of any of the provisions, terms and conditions of this agreement.
THIS AGREEMENT binds the parties hereto, their Executors, Administrators and assigns respectively.
The undersigned being the committee chosen by the parties of the second part for the foregoing agreement, hereby authorize and empower Henry H. Parmelee to act for us in our behalf and in behalf of the parties of the second part of said agreement in any and all matters or things necessary or expedient to the carrying out of the provisions of the foregoing agreement and we hereby ratify*3906 and confirm any and all things, matters and acts whatsoever which the said Henry H. Parmelee may do, perform, transact, and carry on.
(Signed) JACOB KALTZ
(Signed) J. KORANSKY
(Signed) C. HELLMAN
IN WITNESS WHEREOF, party of the first part and parties of the second part have hereunto subscribed their names and affixed their seals the day and year first above written as individuals, or partners, or corporation as the case may be.
EAGLE PIECE DYE WORKS,
E. H. REYNIER, Pres.
[There then follows a list of names of petitioner's customers, parties of the second part.]
Signed, Sealed and delivered in the presence of
(Seal) JOSEPH PLATT, Sec'y.
The goods salvaged from the fire were sold to the Caroline Waste Co. for $5,500, and this sum, together with the total amount of insurance received by the petitioner, except such as was claimed by the lienors, Van Vlaanderen Machine Co., on the machinery, and the sum of $201.45 received by petitioner from Altman & Grodin on that company's insurance policy, were turned over to the trustee, Henry H. Parmelee, for disbursement among the silk manufacturers in accordance with the terms of the agreement.
In accordance with*3907 the agreement, as later modified, petitioner some months after the fire in 1918 made nonnegotiable notes to a number, but not to all, as originally agreed, of its customers, including A. Salsberg, Hillman & Strauss, Barnes Chemical Co., and A. Unger.
*1365 In carrying out the terms of the agreement as subsequently modified by an understanding of the parties, the precise terms of which do not appear, petitioner allowed in its fiscal year 1919 to those customers who had suffered a loss by the fire the total amount of $29,631.32. This allowance was made in the nature of a trade discount, the petitioner allowing a discount from its regular price for dyeing of 10 per cent, and in all cases where it could do so, that is to say, with about one-third of its customers, increasing its ordinary charge of 4 1/2 cents to 5 cents a yard for dyeing. This increase in the dyeing charge, in those cases in which the customer agreed to it, amounted to about the amount of the discount. No customer who declined to give petitioner its trade after the fire received any compensation from the petitioner for the fire loss. In certain cases, however, petitioner applied to accounts receivable before*3908 the fire the discount for the customer's subsequent loss by fire. A recapitulation of the amount sought to be deducted by the petitioner by reason of the fire loss shows the following:
| Deducted from accounts receivable | $21,729.17 |
| Cash payments | 3,533.59 |
| Settled by notes payable | 3,286.88 |
| Applied to accounts receivable | 1,081.68 |
| Total | 29,631.32 |
2. The officers of petitioner received, during its fiscal year 1919, $50 a week salary. Petitioner's dyer during that year, a man of 24 years' experience in the trade, received about the same salary. The salaries ordinarily paid in one of the largest companies of the trade in the same year ranged from $10,000 to $12,000 for a finisher; $10,000 to $15,000 for a dyer; and $5,000 and more to a salesman; while the salary scale in another smaller company in 1919 ran from $5,000 to the president and $4,000 to the secretary, to $3,000 for the more experienced finishers and dyers.
Certain of the formulas invented by petitioner's dyer are still employed by petitioner in its business.
3. Petitioner's return for its fiscal year ended May 31, 1919, was executed on March 12, 1920, by the accountant of the petitioner to whom*3909 had been given the duty of making out and filing the return. 4. The petitioner kept its books upon the accrual basis.
OPINION.
SIEFKIN: 1. The answer to the principal question, the right to deduct $29,631.32 as an item of expense or as losses sustained from gross income of the fiscal year ended May 31, 1919, depends, to a large extent, upon the construction to be placed upon the agreement of February 5, 1918, as modified, and a determination of the legal *1366 relation of the petitioner to its customers before and after such agreement. To indicate the question involved, we summarize the contentions of the parties. The petitioner insists (1) that when the merchandise of its customers was destroyed by fire in January, 1918, the loss was the loss of its customers, the petitioner, being merely a bailee for hire, was not required to insure the merchandise while in its possession and, no negligence being shown, there was no legal obligation on it to make good the loss; (2) that it did not assume a definite binding liability by the agreement of February 5, 1918, as modified, since that agreement contemplated payments to customers only if they gave the petitioner new business*3910 and payments were directly based upon such business, and was without legal consideration; and (3) that the payments made as allowances granted to customers between June, 1, 1918, and May 31, 1919, were either ordinary and necessary expenses or losses sustained, being used to obtain new business, as a business discount.
The respondent contends (1) that the status of the petitioner to its customers in January, 1918, was that of a bailee for mutual benefit, that the hazardous nature of the business and the custom of the trade created an obligation to insure the customers goods, that the failure to do so created a definite legal liability upon the petitioner at the time of the fire; (2) that the agreement of February 5, 1918, definitely fixed the liability on the petitioner for reimbursement of the losses to the customers, the consideration being the promise of the customers not to sue and the resumption of business relations; and (3) that the deduction of the amount in question as a business expense or a loss between June 1, 1918, and May 31, 1919, is wrong since it is not a trade discount but an allowance for a fire loss which occurred and for which liability was admitted prior to*3911 June 1, 1918, and is, therefore, an accrued liability prior to the year in question.
We are able to follow the petitioner to its first conclusion and to say, upon the evidence before us, that the loss by fire was the loss of the customers. There is no evidence showing that the petitioner expressly bound itself by contract to insure or that there was a custom in the trade to insure. The parties agree that the petitioner was a bailee of work for hire and we are satisfied that the law of New Jersey imposes upon such a bailee only ordinary diligence and that negligence is not proved in this proceeding.
The second step in the petitioner's argument is more difficult to take. Although it may be conceded that forbearance to sue where there is clearly no liability is not legal consideration for a contract, the agreement of February 5, 1918, shows that the parties were treating the situation as one in which there was either a liability on the *1367 petitioner or a very real dispute as to its liability. Whether this treatment arose from an ignorance of the legal rights of the petitioner or from the existence of facts known to both parties, but not proved in this proceeding, we*3912 do not know, but it is clear that the parties regarded the claim against the petitioner as one making litigation possible and that they were seeking to avoid that litigation. Although the earlier rule of law in England recognized no distinction in regard to the sufficiency of claim which the claimant promised to forbear to litigate other than the broad distinction between good and bad claims, the majority rule in this country undoubtedly is that the intention of the parties constitutes an important element in determining the validity, as consideration, of a promise to forbear from litigation. We believe the facts in this proceeding indicate that the consideration was good. See Williston on Contracts, par. 135, and cases cited under note 78, including ; .
The petitioner also contends that the original agreement of February 5, 1918, was in substance superseded by another understanding or agreement. The facts as to the extent to which the written agreement was modified are extremely meager and doubtful. So far as they appear at all from the evidence, the terms seem to have been a promise by the petitioner*3913 to allow a 10 per cent discount in exchange for a promise by the customers to send their goods to the petitioner for dyeing. This contract the petitioner designates an "executory contract," probably meaning, although that is not clear, that it constituted an offer to give the discount if the goods were turned over to the petitioner for dyeing and that such act constituted an acceptance of the offer. Such an agreement, however, rests upon the theory of the petitioner that the amounts thus paid during the taxable year in question constituted a trade discount, and were, therefore, an expense of business during that year. The facts, however, show that this "trade discount" is directly related on all facts to the fire loss and is even so set up on the petitioner's books. In addition this "discount" was admittedly allowed on some items arising before and not after the fire.
We conclude that the agreement of February 5, 1918, was a valid agreement which, to some extent, defined the relations of the petitioner and its customers, and that the payment or allowance of the $29,631.22 made during the taxable year in question was related to that contract in some manner and closely enough*3914 related to a real or supposed liability on the part of the petitioner to require us to hold that the liability accrued prior to the taxable year in question, and we, therefore, not a proper deduction in the year in which *1368 taken. This is so whether the amount was deducted as an ordinary and necessary expense or as a loss. Upon the theory of the petitioner, or upon any theory, it is extremely difficult to think of the amounts paid as losses at any other time than in January, 1918, when the fire occurred.
2. The facts which we have found with respect to the salaries paid to the petitioner's officers in the fiscal year in question and paid officers and dyers in like corporations during the same year, are not, in our opinion, sufficient to bring the petitioner within the special assessment provisions of the Revenue Act of 1918. No exceptional hardship is shown - ; nor is the payment of inadequate salaries standing alone a ground for a special relief - ; nor, in our opinion, has the petitioner proved that the disallowance of the item of $29,631.32 constitutes an*3915 abnormality. See .
3. The third issue relates to the penalty for delinquency. The petitioner delegated authority to an accountant to execute and file its return. The fact that the accountant did not know that a return for a fiscal year ended May 31, 1919, should have been filed on or before August 15, 1919, under the provisions of sections 241(a) and 227(a) of the Revenue Act of 1918, but thought that the return should be filed at the same time as returns made for the calendar year 1919, does not constitute the accountant any less the agent of the petitioner, or become a mitigating circumstance when the penalty for negligence is being asserted. The provisions of the Act are so plain that any one should be able to understand them, and we do not believe the petitioner can be heard to say that it did not know and its agent did not know provisions of the law which are clear. In this respect also the respondent's action is approved.
Reviewed by the Board.
Judgment will be entered for the respondent.
MURDOCK concurs in the result.