*3802 1. The book reserve set up by the petitioner for the removal of uncompleted hulls from its premises is not an expense "paid or incurred," within the meaning of section 234(a)(1) of the Revenue Act of 1918, and, therefore, is not an allowable deduction in the computation of net income for 1919.
2. Respondent's allocation of amortization allowance approved.
*479 This proceeding is for the redetermination of deficiencies in income and profits taxes of $2,029.34 for 1918, and $23,751.62 for 1919. The petitioner alleges the following errors:
(1) The failure of the respondent to allow as a deduction in computing net income for 1919 the sum of $45,000, said sum representing an ordinary and necessary expense incurred and accrued during the year 1919.
(2) The failure of the respondent to allocate to the year 1918 as a deduction in computing net income $175,313 of the total amortization of war facilities of $188,731.83 allowed by the respondent.
(3) The failure of the respondent to allocate to the year 1919 as a deduction in computing net income $13,418.83*3803 of the total amortization of war facilities of $188,731.83 allowed by the respondent.
The last two allegations were presented in the alternative and are to be considered only if the deductibility of the $45,000 item is denied.
FINDINGS OF FACT.
The petitioner is a Louisiana corporation organized in 1917 with its principal office in New Orleans. During 1918 and 1919 it was engaged in constructing wooden vessels for the United States Shipping Board Emergency Fleet Corporation.
On July 3, 1917, the petitioner secured a Government contract calling for the construction and delivery of six wooden cargo-carrying, 3,500 ton Ferris Type vessels, on a cost-plus $20,000 fixed fee basis. This contract was modified by a supplemental agreement on *480 August 15, 1918, which provided for the purchase by petitioner of the completed shipyard plant at Madisonville, La., for $200,001.
On August 15, 1918, petitioner entered into a contract with the Shipping Board calling for the construction and delivery of six Ferris Type vessels and four Ferris Type barges on a cost-plus $15,000 fee basis.
The signing of the Armistice occurred just as the petitioner, with its shipyard completed, *3804 was ready to operate at full capacity. Work on the four barges was suspended in October, 1918, and in March, 1919, on the six cargo-carrying vessels called for by the contract dated August 15, 1918, and on Hull No. 215 under the contract of July 3, 1917.
On July 9, 1919, after a series of conferences in Philadelphia between petitioner's president and a Government representative, two termination agreements were entered into by the contracting parties for the purpose of canceling and annulling the original contract of August 15, 1918, and canceling the construction and delivery of Hull No. 215 under the contract of July 3, 1917.
Under the termination agreements the Government agreed to reimburse petitioner for expenditures made and incurred; to pay all ship construction costs, including work, labor and materials; and to transfer title to the hulls and ways to petitioner. At the conferences preliminary to the signing of the termination agreements the Government representative fixed $10,000 or $15,000, as the allowance per ship for the demolition, removal or other disposition thereof.
The articles in the two termination agreements pertinent to the hulls are set out below. That*3805 portion of the termination agreement relating to the contract of August 15, 1918, follows. (Herein Contractor refers to petitioner, Owner to United States Shipping Board.)
ARTICLE V
Disposal of hulls. - 1. The Contractor, without expense to the Owner, shall remove or otherwise dispose of two uncompleted hulls Nos. 2621 and 2622, now on the ways of the Contractor at Madisonville, Louisiana, and does hereby for itself, its successors and assigns release the Owner and the United States of and from all and all manner of claims and demands of every nature whatsoever arising or which may arise out of the removal or other disposition of same.
2. The Owner hereby sells, assigns, transfers and delivers to the Contractor said two (2) uncompleted hulls, together with all partly finished component ship parts on hand constructed for said hulls but not erected and one stern dock and eight (8) pontoons which were constructed and paid for by the Owner and which are now in the possession of the Contractor.
ARTICLE VI
Title. - 1. Except as herein expressly provided, title to all raw materials and finished products, known as direct materials, acquired or procured by the *481 *3806 Owner or the Contractor for the purposes of the original contract shall vest or remain in the United States.
2. Neither the Owner nor the United States shall have any right, title or interest in or to the partly completed hulls Nos. 2621 and 2622, or the partly finished component ship parts constructed for said hulls but not erected herein transferred to the Contractor.
3. * * *
The corresponding articles of the other termination agreement, relating to the contract of July 3, 1917, as amended, state:
ARTICLE VII
Hull #215. - 1. The Contractor, without expense to the Owner, shall remove or otherwise dispose of the uncompleted Hull No. 215 now on the ways of the Contractor, together with all partly finished material constructed for said hull but not erected, at Madisonville, Louisiana, which the Owner hereby sells, assigns, transfers and delivers to the Contractor and the Contractor does hereby for itself, its successors and assigns release the Owner and the United States of and from all manner of claims and demands of every nature whatsoever arising or which may arise out of the removal or disposition of the same.
ARTICLE VIII
Title. - 1. Title to all raw*3807 material or finished products except as expressly herein provided, procured for the construction of the hull herein cancelled, shall vest or remain in the United States.
2. Neither the Owner nor the United States shall have any right, title or interest in or to the partly completed hull No. 215, and the partly finished material constructed for said hull but not erected, herein transferred to the Contractor.
Both termination agreements end with mutual convenants, that the Government shall be released from all claims arising out of the contracts, and that the petitioner waives its right to all prospective profits therefrom.
Included in the amounts paid petitioner under and by virtue of the termination agreements was an allowance of $45,000 for the demolition and removal of the hulls, but due to the disallowance of other items claimed as part of the construction costs by the Cancellation Department of the Shipping Board, petitioner was forced to use this allowance for other expenses. The hulls were not removed in 1919, nor was any portion of the allowance therefor expended for that purpose by petitioner.
Petitioner's superintendent estimated the cost of removing the uncompleted*3808 ships at $45,000, and this amount was set up on the books as a reserve. However, no contract was entered into for such removal in 1919, or thereafter, and the hulls are still standing on the property. Petitioner has had several offers to buy the property, but on account of the ships being there, and the cost of getting them off, has been unable to get 5 cents on the dollar. In June, 1924, an offer was *482 obtained from Abry Bros., a removal concern, whereby they agreed to remove the hulls and clear the site for $38,060.
The petitioner's books of account were kept in accordance with the accrual system of accounting.
Petitioner returned the $45,000 as gross income in the year received and claimed a deduction thereof as an ordinary and necessary expense incurred or accrued in 1919, which was disallowed by respondent.
The respondent determined the amortization allowance to be $188,731.83, and allocated $164,215.57 to 1918 and $24,516.26 to the period January 1, 1919, to May 3, 1919.
OPINION.
MORRIS: The first allegation of error urged by the petitioner relates to a deduction, claimed by it in the computation of net income for 1919, of a sum of $45,000 allowed*3809 by the United States Shipping Board Emergency Fleet Corporation, under certain termination agreements hereinbefore referred to, which amount the respondent has disallowed. Section 234(a)(1) of the Revenue Act of 1918 provides:
That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered, * * *
If the amount in question is deductible in the year 1919 as contended by the petitioner, it must have been "paid or incurred during the taxable year." The petitioner admits that no part of the allowance made by the Government was actually paid for the removal of the hulls in 1919, and, furthermore, that no contract had been entered into in that year, or at any time since then (other than the termination agreements entered into with the United States Shipping Board), by which it was bound to pay the sum of $45,000 for the demolition and removal of said hulls. Therefore, if the expense was incurred*3810 at all in 1919, it must have been by virtue of the termination agreements in which the disposal of these hulls was provided for. While those agreements provided that the petitioner, without expense to the United States Government, "shall remove or otherwise dispose of" these hulls, it is clear from the context that it made little or no difference to the Government whether they were in fact disposed of or not, which is borne out by the fact that title to the uncompleted hulls passed to the petitioner under those agreements.
As we view the situation, the petitioner realized in 1919 that these uncompleted hulls would ultimately have to be removed from the *483 premises, the cost of which, estimated by its superintendent to be $45,000, is set up in its books of account as a reserve to provide for this contingent expense.
Since the amount claimed as a deduction was neither "paid or incurred" within the meaning of section 234(a)(1) supra, we are of the opinion that the action of the respondent in disallowing this amount as a deduction in 1919 was proper, and we so hold.
The petitioner has offered no evidence in support of the second and third allegations of error herein, *3811 and, therefore, since the determinations of the respondent are regarded as prima facie correct in proceedings before us, we must, under the circumstances approve his findings with respect to those issues.
Judgment will be entered for the respondent.