*2562 Held that the deduction claimed was not an expense "incurred" during the taxable period and therefore that it is not a proper deduction for that period.
*954 This is a proceeding for the redetermination of a deficiency in income and profits taxes for the fiscal year ended November 30, 1920, *955 in the amount of $1,957.66. The errors alleged in the petition are, first, denial of a deduction of $4,294.92, alleged expenses in the removal of an abandoned logging spur; second, reduction of invested capital by a prorated portion of the income tax payable during the taxable period upon income of the preceding taxable period; and, third, denial of a deduction of $310, representing Christmas gifts or bonuses to employees.
Upon hearing the petitioner has abandoned the second allegation of error mentioned and the respondent has conceded error in respect of the third issue.
FINDINGS OF FACT.
The petitioner is a corporation with its principal office at Denver, Colo.
In 1914 or 1915 the petitioner acquired from the Department of Agriculture timber*2563 rights on two tracts of land located in the vicinity of La Madera, N. Mex. In connection with its logging operations upon one of these tracts the petitioner caused the construction of a logging spur approximately 23 miles long and connecting with the main line of the Denver & Rio Grande Railroad at La Madera, where the petitioner had a sawmill. The rails used in the spur were acquired by lease from the railroad mentioned upon an annual rental based on track miles and payable yearly in advance at January 1. The petitioner was required to deliver the rails to the main line of the railroad at La Madera when the logging operations served by the spur were completed.
Sometime in 1920 the timber on the leased tract served by the spur had all been cut and the petitioner desired to abandon the spur. It was necessary to remove the rails and such ties as were valuable and either return the rails to the railroad company or relay them to serve other of the petitioner's operations. Ownership of the ties does not appear. The petitioner was anxious to have the rails lifted and returned to the lessor or put to useful service before another annual rental payment became due. It was further*2564 desirous that the rails be removed before winter because of the possibility that washouts on the line during that period would necessitate roadbed repairs before the rails could be taken out in the spring.
In September, 1920, the petitioner and one Allen, who was foreman of the section gang servicing the spur, entered into a verbal contract under the terms of which Allen was to take up the rails. It was agreed that Allen was to be paid $200 per track mile for his services. The petitioner was obliged to maintain at the scene of operations a locomotive, necessary cars, and a train crew, so that the rails could be carried away as they were lifted.
*956 The lumbering operation served by the spur was situated at an altitude between 7,500 and 9,000 feet above sea level in a region of very severe winter conditions, including deep snows and frozen ground. At the time the contract above mentioned was made the parties did not consider it likely that removal of the rails could be effected during 1920. It appears that Allen did not commence the removal until the spring of 1921.
The books of the petitioner were kept on the accrual basis. When the contract for removal of the*2565 rails was made the petitioner set up on its books a reserve in the amount of $10,000 to cover expenses thereunder.
Allen proceeded with the removal of the rails in the spring of 1921 and completed his contract some time in May or June of that year. The total cost of the work was then determined to be $4,294.92, which amount includes payment to Allen at the rate of $200 per track mile removed and the maintenance of the petitioner's locomotive, cars and train crew used in the operations. Part of the sum mentioned had been advanced to Allen for payment of his laborers as the work progressed. No such payments were made during 1920. It appears that only seventeen miles of track were actually removed.
The petitioner now claims a deduction for the fiscal year ended November 30, 1920, in the amount of $4,294.92, representing the amount expended for removal of the rails. The respondent has determined that the deduction claimed is a proper deduction for the fiscal year ended November 30, 1921, and has allowed it for that year.
The difference between the $10,000 reserve set up in the fiscal year ended November 30, 1920, and the actual expense as determined in the fiscal year ended*2566 November 30, 1921, was reported as income by the petitioner in the taxable period last mentioned.
OPINION.
LOVE: Two of the three issues presented by the pleadings in this proceeding have been settled by agreement of the parties. The petitioner concedes the correctness of the respondent's determination relative to invested capital, and the respondent concedes that the petitioner is entitled to a deduction of $310, representing Christmas bonuses to employees during the taxable period.
Upon undertaking consideration of the third issue it may first be pointed out that the petitioner is not seeking deduction of the $10,000 reserve set up during the fiscal year ended November 30, 1920 (hereinafter referred to as the year 1920), but is claiming a deduction for *957 the said year of $4,294.92, representing the actual expense of the operation which the reserve was intended to cover. The respondent contends that the deduction is properly a deduction from income of the fiscal year ended November 30, 1921 (hereinafter referred to as the year 1921), and he has allowed it accordingly.
It appears that in September, 1920, lumbering operations of the petitioner on a tract of leased*2567 land situated approximately twenty-three miles from La Madera, N. Mex., were completed and the petitioner desired to abandon a lumber spur serving the operations mentioned and connecting with the main line of the Denver & Rio Grande Railroad at La Madera.
The rails (and possibly the ties) in use on this spur were held by the petitioner under a lease which required payment of an annual rental in advance on January 1 of each year. Because of this and the possibility of damage to the roadbed and rails if the spur were snowed in for the winter, the petitioner was anxious to have the rails lifted and returned to the lessor before the next annual rental fell due. In September, 1920, it entered into a verbal contract with Allen whereby the latter agreed to remove the rails and the petitioner agreed to pay $200 per track mile for such service and to furnish a locomotive, cars and a train crew. At the time this contract was made the parties doubted that the rails could be removed before the following spring and apparently the removal was not commenced until some time in 1921.
Before closing its books for 1920 the petitioner set up a reserve of $10,000 to cover the removal of the rails. *2568 The removal was completed in May or June, 1921, and the total cost, including payments to Allen and maintenance of the petitioner's locomotive, cars and train crew, was determined to be $4,294.92. The actual payment of this amount occurred in 1921.
The petitioner now claims a deduction of the $4,294.92 as an expense properly accrued in 1920 at the time the contract was made. The respondent contends that no liability was incurred during 1920 and that the expense was not properly accrued in that year. The question for determination therefore is whether or not a liability of the petitioner for payment of the deduction claimed was created or incurred simultaneously with its agreement with Allen. We will not attempt to distinguish between such portion of the deduction claimed as represents payments to Allen and such portion as represents expenses of the petitioner's locomotive, carsAnd train crew, because, in our view, the petitioner's theory rests upon a false predicate, to wit, that liability for the payment eventually made was *958 "incurred" simultaneously with the making of the contract. The contract was an executory one calling for future service by Allen. When it*2569 was made the only immediate effect was the incidence of the obligations of the parties to keep their contract. And the measure of such an obligation is not the contract price but the response in damages for its breach. The obligation was therefore a contingent one and, the contingency not happening, such a liability was never incurred. We think no liability was incurred by the petitioner under its contract with Allen until, at the time in 1921 contemplated by the parties when making the contract, Allen commenced his performance. In other words, the agreement made in 1920 did not then incur a liability but was simply an agreement under which a liability would be incurred in the future. See .
The petitioner seeks to draw an analogy between its case and the facts leading to our determinations in ; , and several similar decisions. In the proceedings mentioned the petitioner had in each instance breached a contract or contracts in the taxable year and upon the accrual system had set up reserves to meet liabilities incurred*2570 by reason of the breach. Settlements of such liabilities were effected in subsequent years and the petitioner claimed appropriate deductions for the year in which the breach occurred. We held the liabilities incurred upon the breach and that the deductions were properly claimed. The instant proceeding is distinguishable in that we hold no liability was incurred in the taxable year. The petitioner's case is more nearly analogous to the facts in , cited by both parties, in which we held that unless the amount claimed as a deduction represented a liability either paid or incurred in the taxable year it was not allowable. In that proceeding it was found that the petitioner, taking cognizance of an anticipated expense, set up a reserve to cover the same. But in the taxable year it neither paid nor incurred the liability and consequently was denied the deduction claimed. In , the liability was likewise incurred in the taxable period for which the deduction was allowed.
It follows that the respondent's denial of the deduction of $4,294.92 as an expense properly accrued*2571 during the taxable period involved is approved.
Judgment will be entered under Rule 50.