*1570 1. In 1918 the petitioner and the United States Shipping Board Emergency Fleet Corporation entered into two contracts for the construction of 12 ocean-going tugs at a flat contract price per tug. These contracts were canceled and the petitioner's compensation fixed by an agreement executed on October 28, 1919. The tugs were completed and delivered to the Fleet Corporation in 1919. An audit contemplated by the contract was not completed until some time in 1920, when petitioner received a small balance due it. Held, that the income realized by the petitioner under the settlement agreement accrued in 1919.
2. For the completion of its contracts the petitioner borrowed money from the Fleet Corporation, which was secured by mortgages upon its plant. The petitioner became financially embarrassed and was unable to pay interest upon its loans from some time in 1920. In 1922 the Fleet Corporation, being unable to collect its indebtedness in full, accepted $45,000 in satisfaction of its claim for $200,000 and released the mortgages upon the petitioner's plant. Held, that this settlement reduced the amortizable cost of the war facilities borne by the petitioner to the extent*1571 of $155,000.
3. The respondent has spread the amortization allowance over the amortization period in accordance with the petitioner's sales in the period. Held, that the amortization allowance should be spread in accordance with the net incomes of the taxable periods comprehended by the amortization period.
4. The claim of a loss of useful value of the petitioner's plate and angle shop in 1920 is disallowed.
*926 The Commissioner determined a deficiency of $102,225.80 in the petitioner's income and profits tax for 1920. The issues presented by the petition are:
(1) Whether income received in the settlement of contracts with the United States Shipping Board Emergency Fleet Corporation was income of the year 1919 or of the year 1920.
(2) Whether the partial cancellation of certain mortgage indebtedness in the year 1922 operated to reduce the amortization deduction to which the petitioner would otherwise have been entitled.
(3) Whether amortization has been properly allocated as between the calendar years*1572 1918 and 1919.
(4) Whether the petitioner in 1920 suffered a loss of the useful value of its plate and angle shop.
FINDINGS OF FACT.
The petitioner is a Massachusetts corporation. In September, 1917, it bought a small shipbuilding plant at South Somerset, consisting of a marine railway, a small blacksmith shop, a joiner shop and mill, and office building, paying $40,000 in cash for the property. Two schooners under construction were taken over and completed and 10 acres of land were subsequently purchased.
On February 23, 1918, the petitioner entered into a contract (designated as No. 194 W.C.) with the United States Shipping Board Emergency Fleet Corporation (hereinafter referred to as the Fleet Corporation) for the construction of six wooden oceangoing tugs to be used in the prosecution of the war, at a price of $235,000 each. The contract provided for the payment of (1) 10 per cent of the conttract price of the six tugs, 30 days after the signing of the contract; (2) installments of 10 per cent of the contract price of each tug as the work thereon progressed to certain stages; and (3) the balance of the contract price of each tug upon its delivery to and acceptance*1573 by the Fleet Corporation. The contract also provided that the price was based upon the existing wage scale and that upon an increase of the wage scale the Fleet Corporation should reimburse the petitioner for the additional costs. The contract further required petitioner to construct, equip, and maintain at its own expense a complete shipbuilding plant adequate to secure the construction and delivery of the tugs as required by the contract.
*927 On July 15, 1918, the petitioner entered into another contract (designated as No. 391 W.C.) with the Fleet Corporation for the construction of six additional tugs on substantially the same terms as the contract of February 23, 1918.
On April 9, 1918, the petitioner entered into another contract (designated as Marine Railway Contract No. 3) with the Fleet Corporation for the construction of a marine railway capable of handling much larger vessels than its then existing railway. This undertaking involved the construction of a wharf adjacent to the railway. For facilitating this work the Fleet Corporation loaned the petitioner $100,000 secured by a mortgage on a part of the petitioner's plant. The mortgage was duly executed, *1574 delivered, and recorded, and the $100,000 loan was used to pay for the construction of the marine railway, which is part of the facilities upon which the petitioner claimed amortization and upon which the Commissioner allowed amortization.
Owing to the increased cost of labor and materials prescribed by the Fleet Corporation for the construction of the tugs, it became apparent in the fall of 1918 that the payment of $235,000 per tug provided for in the two contracts above referred to would be insufficient to meet the actual cost of construction. On April 24, 1919, the petitioner and the Fleet Corporation entered into an agreement whereby an additional loan of $300,000 was made to the petitioner. This loan and the previous loan of $100,000 were secured by a mortgage on the plant and all properties used in connection therewith.
On May 21, 1919, the Fleet Corporation loaned the petitioner an additional sum of $25,000 for use in connection with the construction of the marine railway and a third note and mortgage were duly executed, delivered, and recorded. This made the total of the loans by the Fleet Corporation to the petitioner $425,000, of which $125,000 had been used on the*1575 marine railway and the remainder on the 12 tugs.
In June, 1919, the Fleet Corporation gave orders to the petitioner to suspend work under the two contracts. At that time five of the tugs had been completed and delivered and the other seven were in process of construction.
On October 28, 1919, the petitioner entered into an agreement with the Fleet Corporation, which, after reciting previous transactions between the parties, provided for the cancellation of the two contracts for the construction of the tugs, that an audit should be made of the costs of constructing the 12 tugs, and that in full compensation and settlement for the cancellation of the contracts and for the performance of the agreement then made the Fleet Corporation should pay to the petitioner (a) the total costs to date of constructing *928 the 12 tugs; (b) a fee for profit of 8 per cent of such costs; and (c) the further sum of $120,000 for depreciation of petitioner's plant. The contract provided in detail as to what should be included in the costs of the tugs, including to a limited extent executive salaries, but expressly excluding "plant depreciation and amortization other than specified" in item*1576 (c) above.
The contract further provided that the seven unfinished tugs should be completed to the point of seaworthiness and delivered to the Fleet Corporation and that the petitioner should be paid the additional costs puls 10 per cent thereof for profit, to be determined by an audit. From the amounts thus agreed to be paid for work done or to be done it was provided that there should be deducted the payments already made except those secured by the three mortgages. Any balance due the petitioner was to be credited and applied to the payment of the three mortgages until their total had been reduced to $200,000, and the remainder only was to be paid to the petitioner. Except for such application the mortgages were to be paid according to their terms.
The seven unfinished tugs were completed to the point of seaworthiness and delivered to the Fleet Corporation in November and December, 1919, the last two being delivered on December 4, 1919. The audit called for by the contract of October 28, 1919, was not completed until April, 1920. In May, 1920, a payment of $11,833.63 was made to the petitioner as a final settlement under the contract of October 28, 1919. Subsequently*1577 some clerical errors were discovered in the audit of the costs under contracts Nos. 194 W.C. and 391 W.C., and an additional and final payment of $3,107.93 was made to the petitioner on October 29, 1920, making the total amount received by the petitioner in 1920 in settlement of the contracts $14,941.56.
The petitioner made a claim for the amortization of its war facilities. The total cost of the buildings, machinery, equipment and other facilities constructed, installed or acquired after April 6, 1917, for the production of articles contributing to the prosecution of the war, was $456,566.62. The residual value of these facilities on October 1, 1919, was $100,341.77. Of the difference of $356,224.85, $120,000 was covered by compensation under the agreement of October 28, 1919.
The petitioner's amortization period ended on September 30, 1919.
Interest on the $200,000 of mortgage indebtedness remaining due on the above described mortgages was not paid after August, 1920.
On July 13, 1922, the petitioner and the Fleet Corporation entered into a contract by which the petitioner released its claim for shortage in materials and paid the Fleet Corporation $45,000 in cash in*1578 discharge *929 of all further liability, either for principal or interest, for the balance due on the three mortgages above referred to. This contract recited at length the various contracts entered into between the parties and the loans made, stating that the loan of $300,000 was made because of the excessive cost of contructing the tugs and that on October 28, 1919, a compromise was reached and full and final adjustment made. This contract contained the following:
WHEREAS, due to the excessive cost of construction, beyond previous estimates, of the aforesaid twelve tugs under, and according to, the terms of the aforesaid respective contracts and to a consequent loss to the Contractor if the tugs should be completed under said contracts and paid for on the basis prescribed therein, the Contractor applied to the Corporation for additional financial assistance in performing the said contracts, whereupon and by reason thereof, thereafter, to wit, on the 29th day of April, 1919, a certain other contract (designated as Financing Agreement File No. 3430) was entered into by and between the parties, by the terms of which, the Corporation agreed, among other things, to advance*1579 from time to time at its option to the Contractor for use by it in performing the said contracts to build said tugs, moneys up to the amount of three hundred thousand dollars, in addition to any amounts theretofore advanced under said contracts and in excess of the payments called for thereby * * *
* * *
WHEREAS, after the completion of the marine railway, machine shop, and the necessary accessories to its plant, the Contractor began the operation thereof, and has continued its efforts to operate the same, but, owing to the serious general depression in the shipping industry then prevailing and still continuing, and to the widespread financial stringency prevailing throughout the country, the operation of the plant has been and still is unprofitable, thereby compelling the Contractor to incur large indebtedness to banks and others to finance its operations, which have continued to this time at a loss, with the result that its current liabilities now largely exceed its quick assets, while its fixed assets possess insufficient earning power to produce any net revenue with which to pay the interest on its indebtedness to the Corporation aside from making any reductions in the principal*1580 thereof, so that the corporate resources of the Contractor are practically exhausted and its credit destroyed, thereby creating a condition of insolvency on its part; and
WHEREAS, the aforesaid securities held and owned by the Corporation consisting of the three notes and mortgages aforesaid, now of the agreed reduced face value of two hundred thousand dollars, have little or no market value, because not attractive to investors generally, and the plant covered by the mortgages is undesirable as an asset to the Corporation and would be impossible to advantageously liquidate, either as a going concern, or at its scrap or junk value, but the actual intrinsic value thereof is greater to the Contractor which has invested heavily therein, thereby creating an inducement to it to refinance itself on a more satisfactory basis by raising additional capital through the efforts of its officers and stockholders by pledging their individual credit and continuing operations until the return of normal conditions.
The petitioner kept its books of account and made its income-tax returns for the years 1918, 1919, and 1920 upon the accrual basis.
*930 Its books of account show losses from*1581 operations in 1918 and 1919 of $26,324.84 and $16,483.29, respectively, and they show a profit for 1920 of $20,305.17. The petitioner's tax returns for 1918 and 1919 showed net incomes upon which taxes of $388.68 and $236.70, respectively, were assessed. No tax was assessed upon the 1920 return. The respondent has determined that the petitioner had a net loss for 1918, after the deduction from gross income of $54,297.58 for amortization, of $14,833.92; a net loss for 1919, after the deduction of $26,927.27 for amortization, of $479,463.23; and a profit for 1920 of $616,336.16, which was reduced to a net taxable income of $136,872.93 by deducting from the profit of $616,336.16 a net loss for 1919 of $479,463.23.
The method used by the Commissioner in determining the taxable income of 1920 in shown in the Commissioner's letter dated October 20, 1923, as follows:
| 1920 | |||
| Net income as disclosed by books | $20,305.17 | ||
| Additions to income: | |||
| Loss on schooner "Hesper" allowed in 1918 | $40,373.10 | ||
| Depreciation and amortization claimed | 234,554.44 | ||
| Overhead expense allowed in 1919 | 3,960.59 | ||
| $278,888.13 | |||
| Total income from supplemental Government contract as shown in U.S. Shipping Board settlement of 1920 | 4,011,372.90 | ||
| Less: Contractual amortization | 120,000.00 | ||
| Balance | 3,891,372.90 | ||
| Less: Amount applicable to five completed boats in 1919 | 1,175,000.00 | ||
| 2,716,372.90 | |||
| Additional allowance made in 1920 | 3,107.93 | ||
| 2,998,368.96 | |||
| Total | 3,018,674.13 | ||
| Deductions from income: | |||
| Depreciation allowed | 13,675.36 | ||
| Overaccrual of interest from 1919 | 2,746.46 | ||
| Adjustment of towing charges | 238.75 | ||
| Inventory depreciation from 1918 | 18,783.04 | ||
| Liberty bond, interest exempt | 2,125.00 | ||
| Loss on sale of automobile | 530.00 | ||
| Total cost Government contracts as above in revenue agent's report | $3,774,612.73 | ||
| Add cost of tug charged off in 1918 | $282,521.85 | ||
| 4,057,434.30 | |||
| Less cost of five completed boats applicable to 1919 | 1,696,313.87 | ||
| $2,361,120.43 | |||
| 2,399,249.04 | |||
| Loss on material taken in payment from U.S. Shipping Board | 10,280.79 | ||
| $2,409,529.83 | |||
| Net profits for 1920 | 609,144.30 | ||
| Less 1919 loss applicable to 1920 | 414,224.65 | ||
| Taxable income, 1920 | 194,919.65 |
*1582 *931 The computation above set forth was modified in the deficiency notice forming the basis of this proceeding dated June 30, 1925, as follows:
| Net income as disclosed by office letter dated Oct. 20, 1923 | $609,144.30 |
| Additions: | |
| Depreciation | 7,191.86 |
| Total | 616,336.16 |
| Deductions: | |
| 1919 loss | 479,463.23 |
| Net income for 1920 as corrected | 136,872.93 |
In 1919 the petitioner's plant was equipped for the construction and repair of wooden vessels only. After the close of the war the Fleet Corporation discontinued the construction of wooden vessels. The petitioner saw in 1919 that there would be no further use for its plant unless it were equipped to build or repair iron or steel vessels. It was advised by some person connected with the Fleet Corporation that if its plant were equipped to repair steel vessels it would be able to obtain profitable contracts. Accordingly, in 1919, it started the construction of a plate and angle shop which would enable it to make repairs on steel vessels. This shop was finished sometime in 1920 and equipped with a heating furnace, bending machine, purches, shears, drills, and overhead cranes for handling heavy plates. All*1583 of this equipment is housed in a sheet-iron building upon the petitioner's property. The total cost of this house and equipment approximated $70,000. The petitioner has never made any use of the plate and angle shop. It has never been able to obtain any contracts from the Fleet Corporation or from others for the repair of steel vessels. For a period of two or three years *932 following the completion of the shop the petitioner had hopes that it could be utilized but after there had been changes in the personnel of the Fleet Corporation it concluded that the plate and angle shop and the equipment which had been installed therein had no useful value.
OPINION.
SMITH: 1. The petitioner complains, first, that the respondent has erroneously held that the whole of the amount received by it on certain contracts with the Emergency Fleet Corporation during the years 1918, 1919, and 1920 was income taxable in 1920.
In its brief the petitioner contends as follows:
(a) When a government contract is cancelled and, by agreement between the parties, the contractor is paid his actual cost plus a percentage for profit, less advances already made, in place of a fixed sum payable*1584 by installments as the work progressed, the instalments earned and actually paid in previous years while the contract was in force are not gross income of the year in which the final settlement in made.
* * *
(b) When a government contract is cancelled and an agreement is entered into with respect to the compensation which the contractor is to receive, based on the actual cost incurred by him up to the date of cancellation, and all that remains to be done is an audit by a government agency of the cost of the work already performed by the contractor as shown by his books, the income arising from the agreement, in the case of a taxpayer keeping his books and making returns upon the accrual basis, is not income in the year in which the audit is completed and the balance paid, if the work was done and the settlement was agreed upon in a previous year.
The respondent defends his computation of taxable net income for 1920 and his action in allocating to that year an alleged profit upon the completion of the contracts by citing article 51, Regulations 62, in which it is provided:
* * * Such items as claims for compensation under canceled Government contracts constitute income for*1585 the year in which they are allowed or their value is otherwise definitely determined.
In his brief the respondent submits that it is immaterial, so far as the present petitioner is concerned, whether the income from the contracts be allocated to the year 1919 or to the year 1920, for if such income were allocated to 1919, it would serve only to reduce but not to wipe out the net loss for that year, so that in any event the taxable net income of 1920 would not be affected. It is not clear, however, that this is so, for under the regulations of the Commissioner the amortization allowance is to be spread over the amortization period in accordance with the net income assignable to the taxable periods contained therein. See art. 185, Regulations 45.
*933 In , the principle was laid down that where a taxpayer makes his tax return upon the accrual basis and all the events have occurred in the taxable year "which fixed the amount of the [munitions] tax and determined the liability of the taxpayer to pay it," the tax accrued within the year within the meaning of sections 12(a) and 13(d) of the Revenue Act of 1916. *1586 The same principle was applied by the Supreme Court in ; ; ; ; . The Board has also held in numerous cases that the accrual of items of income or of expense is dependent upon whether events have occurred which fix the amount to be received or which fix the liability to pay. ; ; ; .
The contracts which the petitioner had with the Fleet Corporation were fully completed in 1919. The petitioner and the Fleet Corporation had entered into a final agreement in 1919 as to the compensation which the petitioner was to receive under its contracts. All that remained to be done at the close of 1919 was the making of an audit by*1587 the representatives of the Fleet Corporation of the petitioner's books of account for the purpose of determining the cost to the petitioner of the construction of the vessels.
We are of the opinion that the contention of the respondent that all of the income from these contracts was income of 1920 is not sustained by article 51 of Regulations 62, above quoted; for the compensation to be received by this petitioner was fixed by the agreement of October 28, 1919, and the contracts were fully performed within that year. It is furthermore to be noted that the petitioner's books of account, kept upon the accrual basis, show the income from the contracts as income of the years in which the monies were received from the Fleet Corporation, and not all as income of 1920, in which a small balance due the petitioner was paid. The contentions of the petitioner upon this point are sustained.
2. The amortization issue raised by the petition presents two questions - first, the amount to be amortized, and, second, the allocation or spread of that amount over the amortization period. It is stipulated that the cost of the amortizable facilities was $456,566.62; that the amortization period*1588 ended September 30, 1919; and that the facilities on that date had a residual value of $100,341.77. Under the agreement of October 28, 1919, the petitioner was awarded $120,000, which it concedes represents contractual amortization and *934 therefore reduces the amount to be amortized to $236,224.85. The petitioner contends that this is the amount of the amortization to be spread over the amortization period and the respondent admits that this would be the case were it not for the fact that under the contract of July 13, 1922, $155,000 of the indebtedness of the petitioner to the Fleet Corporation was canceled. The respondent contends therefore that the only cost of the amortizable facilities borne by the petitioner was $81,224.85, or the difference between $236,224.85 and $155,000.
Section 234(a)(8) of the Revenue Act of 1918 is as follows:
In the case of buildings, machinery, equipment, or other facilities, constructed, erected, installed, or acquired, on or after April 6, 1917, for the production of articles contributing to the prosecution of the present war, and in the case of vessels constructed or acquired on or after such date for the transportation of articles*1589 or men contributing to the prosecution of the present war, there shall be allowed a reasonable deduction for the amortization of such part of the cost of such facilities or vessels as has been borne by the taxpayer, but not again including any amount otherwise allowed under this title or previous Acts of Congress as a deduction in computing net income. At any time within three years after the termination of the present war the Commissioner may, and at the request of the taxpayer shall, reexamine the return, and if he then finds as a result of an appraisal or from other evidence that the deduction originally allowed was incorrect, the taxes imposed by this title and by Title III for the year or years affected shall be redetermined and the amount of tax due upon such redetermination, if any, shall be paid upon notice and demand by the collector, or the amount of tax overpaid, if any, shall be credited or refunded to the taxpayer in accordance with the provisions of section 252.
The same section of the Revenue Act of 1921 provides in part as follows:
* * * At any time before March 3, 1924, the Commissioner may, and at the request of the taxpayer shall, reexamine the return, and*1590 if he then finds as a result of an appraisal or from other evidence that the deduction originally allowed was incorrect, the income, war-profits, and excess-profits taxes for the year or years affected shall be redetermined * * *
Under the above quoted provisions of the taxing acts there can be no question but that the respondent had the right to redetermine the amount of the amortization allowance in the case of this petitioner. In 1922, it was apparent that $155,000 of the cost of war facilities, advanced by the Fleet Corporation and secured by these mortgages, was borne by the Government, which amount was in addition to any amounts borne by the Government under the settlement of October 28, 1919. The respondent has computed the amortization allowance to be $81,224.85. We discover no error in such computation. The fact that the $155,000 cost of war facilities in question was allowed by the Government in settlement of a claim which the Government could not collect in 1922 by reason of the financial standing of the petitioner is not material. The facts are, in the final analysis, that *935 the Government bore the cost of such facilities. In our opinion the decision of*1591 the Circuit Court of Appeals for the First Circuit in , supports this proposition. In that case it was held that, in so far as one contracting with the Government under claim for damages by reason of cancellation of a war contract received compensation for obsolescence with respect to its war facilities, to that extent it has not, within the meaning of section 234(a)(8) of the Revenue Act of 1918, borne the cost of such facilities. It is, therefore, held that the amount of the war facilities to be amortized is the amount determined by the respondent, namely, $81,224.86.
The second question presented with respect to amortization is the allocation or spread of that amount over the amortization period. Article 185 of Regulations 45 requires the amount to be spread in accordance with the net income of the taxable periods comprehended by the amortization period. This regulation has been approved by the Board. ; *1592 ; .
It is manifest that the method of allocating the amortization allowance used by the respondent in this case, namely, according to the sales reported by the petitioner's tax returns for 1918 and 1919, is not in accordance with the Commissioner's regulations. Furthermore, it is apparent that the income from the Government contracts has not been determined upon the accrual basis; for all of the income from all of the contracts has been allocated to the year 1920. With the correction indicated in this opinion the amortization allowance should be allocated in accordance with the net income, and deficiencies, if any, determined accordingly.
The final point for decision is whether the petitioner should be allowed to deduct from its gross income of 1920 the cost of its plate and angle shop which it completed in that year and which it claims had lost its useful value in 1920. The evidence indicates that this shop was started in 1919 and completed sometime in 1920. The petitioner built the plant in the hope that it might obtain contracts for the repair of steel vessels. It was*1593 induced to build the plant by statements made by one or more officials of the Fleet Corporation. It obtained no contract for the repair of steel vessels in 1920 and has never made any use of the plate and angle shop. The petitioner had hopes for two or three years that the Fleet Corporation would give it contracts which would enable it to utilize the shop, but after there had been a change of personnel of the Fleet Corporation the petitioner became convinced that it would never be able to utilize the shop which had been built. So far as the evidence shows, the *936 plant was not obsolete in 1920 for the doing of the work for which it was constructed, nor was it any less valuable for that purpose at the close of 1920 than it was at the date of construction. Upon the record the claim of the petitioner to a deduction for the loss of useful value of the plate and angle shop is not sustained. Cf. .
Reviewed by the Board.
Judgment will be entered under Rule 50.