*247 Decision will be entered under Rule 50.
1. The petitioner, engaged in long term contracts, kept its books and prepared its Federal income tax returns upon a basis of billing clients, in most cases, in accordance with engineers' determinations of percentage of work completed, and deducting therefrom expenses actually incurred. Compensating adjustments were made in the year of completion of contract. Held, that petitioner's method clearly reflected income and that the statute of limitation had run, as to one taxable year, upon the assessment made.
2. Held that petitioner has not shown error in computation of depreciation.
*482 This proceeding involves income tax for the calendar years 1935 and 1936, respondent having determined deficiencies in the sums of *483 $ 2,747.16 and $ 1,060.29 for the two years respectively. The issues presented are whether the petitioner reported its gross profits on long term contracts so as to reflect clearly its net income arising thereunder for the years in question; *248 whether petitioner claimed excessive depreciation allowances; and whether assessment of the deficiency asserted for the year 1935 is barred by the statute of limitations.
FINDINGS OF FACT.
During the taxable years in question petitioner, a corporation organized under the laws of the State of Pennsylvania, was a general contractor engaged in the construction business. Its Federal income tax returns for the years 1935 and 1936 were filed with the collector of internal revenue for the twenty-third district of Pennsylvania, at Pittsburgh.
When a long term contract was obtained, it was petitioner's practice to set up a separate account for that contract. Expenses or charges incurred in connection with such contract were entered in the account relating to that contract under the heading "cost." Bills sent out to the customer were entered in the same account under the heading "billings." Overhead expenses, such as office salaries, were separately considered as expenses, and claimed as business expenses in the returns.
At the close of each of the taxable years there existed unbilled charges against customers which were allocable, under petitioner's accounting practice, to the year so closed. *249 This was due to a lag of from a few days to not more than thirty days between the time of the inception of such charges and the time when the bills were made up and mailed. Book entries of such delayed billings, however, were made for the year in which the charges arose, without regard to time of billing.
In computing its gross profit on a long term contract, petitioner deducted the sum of all entries under the heading "cost" from the sum of all entries under the heading "billings," as of the last day of the calendar year. The difference between the sum of all accounts showing profit and all accounts showing loss was returned as net profit or loss, as the case might be, on long term construction contracts.
The petitioner adopted this accounting method in 1920 and has prepared its income tax returns in accordance therewith, consistently, since that time.
The amount of petitioner's billings against a particular customer depended upon the terms of the contract. On large contracts billings were made, in most cases, in accordance with engineers' determinations of percentage of work completed; in the case of other contracts, different systems, not described by either party, were followed. *250 The figures used were not always obtained from the engineers. In no case did architects' or engineers' certificates showing the percentage *484 of completion during the taxable year of the entire work to be performed accompany the petitioner's income tax returns.
Accounts in petitioner's books in which cost and/or billings entries were made for the years 1935 and 1936, and the amounts of the entries for all years in which these accounts were carried, are shown in the following table, together with a summary showing the totals of all cost and billings entries, and the ultimate excess of the one over the other with respect to each account herein involved:
| SUMMARY | ||
| 1933 | ||
| Cost | Billings | |
| Heinz Memorial Chapel | $ 76,477.10 | $ 68,383.03 |
| Pittsburgh Joint Stock Yds. Co | ||
| Allegheny County Home -- Woodbine | ||
| Fort Pitt Bedding Co. boiler room * | ||
| Fort Pitt Bedding Co. (addition) * | ||
| Foster Memorial Bldg | ||
| Farmers Bank Bldg. alterations | ||
| Steel City Elec. Co | ||
| Jones & Laughlin Steel res. lab | ||
| Pennsylvania Railroad banana warehouse | ||
| United Engineering & Fdry. Co. (fire wall) |
| SUMMARY | ||
| 1934 | ||
| Cost | Billings | |
| Heinz Memorial Chapel | $ 371,501.97 | $ 378,533.05 |
| Pittsburgh Joint Stock Yds. Co | 21,387.49 | 21,094.73 |
| Allegheny County Home -- Woodbine | ||
| Fort Pitt Bedding Co. boiler room * | 30,522.72 | 35,000.00 |
| Fort Pitt Bedding Co. (addition) * | ||
| Foster Memorial Bldg | ||
| Farmers Bank Bldg. alterations | ||
| Steel City Elec. Co | ||
| Jones & Laughlin Steel res. lab | ||
| Pennsylvania Railroad banana warehouse | ||
| United Engineering & Fdry. Co. (fire wall) |
| 1935 | ||
| Cost | Billings | |
| Heinz Memorial Chapel | $ 74,493.81 | $ 79,705.06 |
| Pittsburgh Joint Stock Yds. Co | 14,697.45 | 15,578.04 |
| Allegheny County Home -- Woodbine | 873,421.70 | 860,475.82 |
| Fort Pitt Bedding Co. boiler room * | ||
| Fort Pitt Bedding Co. (addition) * | 73,161.12 | 77,100.00 |
| Foster Memorial Bldg | 256,140.36 | 248,534.75 |
| Farmers Bank Bldg. alterations | ||
| Steel City Elec. Co | ||
| Jones & Laughlin Steel res. lab | ||
| Pennsylvania Railroad banana warehouse | ||
| United Engineering & Fdry. Co. (fire wall) |
| 1936 | ||
| Cost | Billings | |
| Heinz Memorial Chapel | $ 12,367.47 | $ 13,128.76 |
| Pittsburgh Joint Stock Yds. Co | 196,916.25 | 204,359.60 |
| Allegheny County Home -- Woodbine | 467,296.75 | 513,186.37 |
| Fort Pitt Bedding Co. boiler room * | ||
| Fort Pitt Bedding Co. (addition) * | ||
| Foster Memorial Bldg | 133,695.60 | 118,954.65 |
| Farmers Bank Bldg. alterations | 213,993.47 | 210,024.34 |
| Steel City Elec. Co | 21,210.84 | 25,262.87 |
| Jones & Laughlin Steel res. lab | 24,654.26 | 26,537.20 |
| Pennsylvania Railroad banana warehouse | 883.33 | |
| United Engineering & Fdry. Co. (fire wall) | 6,486.79 | 9,280.00 |
| 1937 | ||
| Cost | Billings | |
| Heinz Memorial Chapel | $ 2,425.35 | |
| Pittsburgh Joint Stock Yds. Co | 205,112.69 | $ 232,736.19 |
| Allegheny County Home -- Woodbine | 1,367.64 | 1,935.09 |
| Fort Pitt Bedding Co. boiler room * | ||
| Fort Pitt Bedding Co. (addition) * | ||
| Foster Memorial Bldg | 24,886.91 | 46,202.60 |
| Farmers Bank Bldg. alterations | 8,883.31 | 29,176.10 |
| Steel City Elec. Co | 2,798.81 | 1,401.42 |
| Jones & Laughlin Steel res. lab | 11,500.86 | 8,320.17 |
| Pennsylvania Railroad banana warehouse | 8,075.88 | 10,806.94 |
| United Engineering & Fdry. Co. (fire wall) | 186.53 |
| 1938 | ||
| Cost | Billings | |
| Heinz Memorial Chapel | $ 3,001.57 | $ 6,136.44 |
| Pittsburgh Joint Stock Yds. Co | 98.61 | 1,801.45 |
| Allegheny County Home -- Woodbine | ||
| Fort Pitt Bedding Co. boiler room * | ||
| Fort Pitt Bedding Co. (addition) * | ||
| Foster Memorial Bldg | 1.73 | |
| Farmers Bank Bldg. alterations | ||
| Steel City Elec. Co | ||
| Jones & Laughlin Steel res. lab | ||
| Pennsylvania Railroad banana warehouse | ||
| United Engineering & Fdry. Co. (fire wall) |
| Summary | |||
| Cost | Billings | Profit or loss | |
| Heinz Memorial Chapel | $ 540,267.27 | $ 545,886.34 | $ 5,619.07 |
| Pittsburgh Joint Stock Yds. Co | 438,212.49 | 475,570.01 | 37,357.52 |
| Allegheny County Home -- Woodbine | 1,342,086.09 | 1,375,598.28 | 33,511.19 |
| Fort Pitt Bedding Co. boiler room * | 103,683.84 | 112,100.00 | 8,416.16 |
| Fort Pitt Bedding Co. (addition) * | |||
| Foster Memorial Bldg | 414,724.60 | 413,692.00 | (1,032.60) |
| Farmers Bank Bldg. alterations | 222,876.78 | 239,200.44 | 16,323.66 |
| Steel City Elec. Co | 24,009.65 | 26,664.29 | 2,654.64 |
| Jones & Laughlin Steel res. lab | 36,155.12 | 34,857.37 | (1,297.75) |
| Pennsylvania Railroad banana | |||
| warehouse | 8,959.21 | 10,806.94 | 1,847.73 |
| United Engineering & Fdry. Co. | |||
| (fire wall) | 6,673.32 | 9,280.00 | 2,606.68 |
*253 *485 The petitioner's return for 1935, as to contracts not completed in the taxable year, reflected a loss sustained in the amount of $ 10,520.77, being the excess of the total of its 1935 cost entries over total billings entries, as set out in the foregoing table. The petitioner's return for 1936, as to contracts not completed in that taxable year, reflected a profit of $ 43,229.03, the excess of the total of 1936 billings entries over total cost entries.
The respondent determined that petitioner's method of reporting profit or loss on long term contracts was the percentage of completion method, but that petitioner did not report the correct percentages of completion in the taxable years, nor correctly allocate the percentages of all expenditures under the several contracts to the taxable years. He further determined that gross profit or loss on any contract for a particular year should be that percentage of the total ultimate profit or loss which the amount of cost incurred in that year bears to total cost incurred in respect of the whole contract. The following tables reflect profit or loss on each long term contract as reported by petitioner and respondent's adjustments*254 thereto:
| 1935 | |||||
| Reported | Adjusted | ||||
| Fort Pitt Bedding Co | Profit | $ 3,938.88 | Profit | $ 5,941.81 | |
| Allegheny County Home | Loss | 12,945.88 | Profit | 21,815.79 | |
| Foster Memorial | Loss | 7,605.61 | Loss | 638.15 | |
| Heinz Memorial Chapel | Profit | 5,211.25 | Profit | 775.43 | |
| Pittsburgh Joint Stock Yards | Profit | 880.59 | Profit | 1,291.35 | |
| Reported net loss | 10,520.77 | ||||
| Net profit as adjusted | 29,186.23 | ||||
| Increase in net profit | 39,707.00 |
| 1936 | |||||
| Reported | Adjusted | ||||
| Allegheny County Home | Profit | $ 45,889.62 | Profit | $ 11,661.89 | |
| Farmers Deposit National Bank | Loss | 3,969.13 | Profit | 15,670.71 | |
| Foster Memorial | Loss | 14,740.95 | Loss | 332.50 | |
| Heinz Memorial Chapel | Profit | 761.29 | Profit | 129.24 | |
| Pittsburgh Joint Stock Yards | Profit | 7,443.35 | Profit | 17,167.28 | |
| Steel City Electric Co | Profit | 4,052.03 | Profit | 2,344.05 | |
| Pennsylvania R. R. Banana Warehouse | Loss | 883.33 | Loss | none | |
| United Engineering & Foundry Co | Profit | 2,793.21 | Profit | 2,606.68 | |
| Jones & Laughlin Steel Corp | Profit | 1,882.94 | Loss | 885.07 | |
| Reported net profit | 43,229.03 | ||||
| Net profit adjusted | 48,362.28 | ||||
| Increase in net profit | 5,133.25 |
Respondent determined that the book loss of $ 883.33*255 for 1936 on the Pennsylvania Railroad account, resulting from a cost entry in that amount, should be eliminated and the entry transferred to 1937, because the contract was started late in December 1936; and that the 1937 cost entry of $ 186.53 in the United Engineering & Foundry Co. *486 account should be allocated to 1936, thereby increasing the 1936 cost entry in that amount, for the reason that the contract was started and practically completed in 1936. In computing the ultimate profit on Pittsburgh Joint Stock Yards Co. contract he employed the figure of $ 19,061.46 as cost incurred in 1934, rather than $ 21,387.49, the amount of the 1934 cost entry on petitioner's books; he also excluded both cost and billings entries appearing on petitioner's books in 1938, and therefore allocated to each of the taxable years a percentage of a determined ultimate profit of $ 37,980.71, rather than the ultimate profit of $ 37,357.52 reflected by the books. All contracts here involved were completed in 1937 except Heinz Memorial Chapel and Pittsburgh Joint Stock Yards, which were completed in 1938. In 1937 the gross income was, on the Commissioner's theory, overstated to offset the insufficient*256 profits or losses taken into the years 1935 and 1936.
The Allegheny contract was closed in 1937 at a profit of $ 33,511.19. The Foster Memorial contract was closed in 1937 at a loss of $ 1,032.60. The Allegheny contract was about two-thirds completed in 1935 and the Foster Memorial contract was over 60 percent completed in that year. The Farmers Deposit National Bank contract was 96 percent completed in 1936, and was closed at a profit of $ 16,323.66. The Pittsburgh Stock Yards contract was about 45 percent completed in 1936. The Heinz Memorial Chapel contract was completed in 1938 at a total profit of $ 5,619.07.
In its return for the taxable year 1935 the petitioner claimed the sum of $ 880.31, and for the taxable year 1936 the sum of $ 1,715.67, as deductions for depreciation on its automotive and construction equipment. It used the general rate of 33 1/3 percent in computing its depreciation on these assets. The respondent has determined that total depreciation allowable for 1935 is $ 306.48, and for 1936 is $ 1,252.81, and has adjusted petitioner's reported net income for the two years accordingly.
The petitioner had purchased a boom for a steam shovel in 1932 for $ 1,980.75; *257 had attached it to a shovel purchased in 1929; and had discontinued use of that equipment in 1937.
The respondent determined that 25 percent was the allowable rate of depreciation on petitioner's automotive equipment, with the exception of one International truck, as to which he determined that 20 percent was the proper rate; and that 16 2/3 percent was the rate properly applicable to physical equipment used in construction work, with the exception of the steam shovel boom purchased in 1932, with respect to the undepreciated balance of which he determined that the rate of 25 percent should apply.
*487 The petitioner's income tax return for the taxable year 1935 was filed on March 16, 1936. It reported under the heading "Gross Income" a "total income" of $ 94,256.77. Item 6 under the heading "Gross Income" is labeled "Gross Profit where inventories are not an income-determining factor (Building Account)." The petitioner reported that item as $ 68,347.75. The respondent determined that that item should be increased by $ 39,707; and that petitioner's net income for the year in question, after making certain other adjustments not here in issue, should be increased by $ 35,545.87. *258 Notice of the determination of deficiency for both of the years here in question was given to the petitioner by respondent by letter dated July 9, 1940. Petition was filed with this Court on October 1, 1940.
OPINION.
Three questions here are presented: Has the statute of limitations run as to assessment for the year 1935? Did the respondent err in denying the depreciation claimed by the petitioner? Did he err in adding to the petitioner's income on the ground that the petitioner's system of computing income from long term contracts did not clearly reflect income?
The three-year period of limitations upon assessment had admittedly expired on the date of the deficiency notice. Therefore the respondent had the burden of showing an exception to section 275 (a), Revenue Act of 1934, 1 under section 275 (c), 2 which permits assessment within five years from the date of filing return. ; ; . The five-year period had not run. He could meet that burden by showing that the petitioner*259 had omitted in excess of 25 percent of the amount of properly includible gross income stated in the return. . The petitioner, under the general heading "Gross Income" on its return, reported a total of $ 94,256.77, which included $ 68,347.75 "gross profit where inventories are not an income-determining factor." (However, inventories were actually considered in reporting income.) The respondent in computing the deficiency added *488 thereto $ 39,707 on the theory that in computing income upon long term contracts the petitioner's method did not clearly reflect income. The $ 39,707 is, of course, much more than 25 percent of $ 94,256.77. If the $ 94,256.77 is the amount of "gross income stated in the return" within the intent of section 275 (c) and if the $ 39,707 was "properly includible" in gross income, it is apparent that the respondent has met his burden. The petitioner suggests that there were in 1935 total gross receipts of $ 1,433,705.45 from construction and building work, that therefore the $ 39,707 is not 25 percent of gross income, and that the latter amount can not be said to have been improperly omitted, for the*260 reason that petitioner's return for 1935 was computed upon the same basis as had been used for many years, that the petitioner could not have changed its basis without the Commissioner's permission that the intent of section 275 (c) was to affect those taxpayers so grossly negligent as to omit 25 percent of properly includible gross income, and that, since the petitioner reported in its accustomed manner and could not without permission have done otherwise, it was not thus negligent or within the intendment of the statute. Therefore petitioner argues we have here no omission from properly includible gross income, but an increase in gross profit brought about by the action of the Commissioner. Section 275 (c) refers to 25 percent of gross income "stated in the return." Even though gross receipts were much greater, the petitioner stated in the return $ 94,256.77 as gross income, and we think the 25 percent must be computed upon the amount so stated, despite greater gross receipts. The petitioner, under its method, nowhere indicated on the return any gross receipts. It reported in that respect only the profit from "building account," and obviously intended such to be regarded*261 as gross income. Section 275 (c) plainly means to base the 25 percent not upon other proof of receipts, but upon the return as made by the taxpayer and his computation of gross income therein. We think that it requires us to consider $ 94,256.77 as gross income. Nor can we agree with the petitioner's view that there was not omission, but merely addition on the Commissioner's theory. Though it may be true that on petitioner's customary and theretofore used manner of reporting, it had "omitted" no gross income properly includible, yet the fact remains that it did not report an amount in excess of 25 percent of gross income as reported, under the respondent's view of what was "properly includible" gross income, i. e., if the $ 39,707 added to gross income by the Commissioner was properly includible, that amount had in fact been omitted. We conclude therefore that our only question is whether the amount added was properly includible. This depends upon whether the petitioner's income was properly *489 computed, and in turn requires examination of the petitioner's position with respect to manner of reporting income from long term contracts. The respondent has the burden *262 of showing that the petitioner's method did not properly reflect income.
In the case of most of its long term contracts the petitioner's books were kept and returns were prepared upon the basis of "percentage of completion," under Regulations 86, article 42-4 (a), relative to long term*263 contracts, to the extent that clients were billed in accordance with engineers' determinations of percentage of work completed. Costs actually incurred were entered upon the books, and income tax returns reflected the difference between billings and costs. A very similar system was, in , regarded as the "percentage of completion" system; and the Commissioner so determined here, but determined in effect that it did not clearly reflect income.
Section 41, Revenue Acts of 1934 and 1936, 3 though providing first for the use of a regularly used method, provides also that, if "the method employed does not clearly reflect the income," computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect income. An accounting method, though consistently used by the taxpayer, is not conclusive, and if the method does not clearly reflect income, computation is to be made upon a basis which in the Commissioner's opinion will do so. ; .*264
We think that , is authority that the petitioner's method here does accurately reflect income. In both cases actual expenses were deducted from*265 bills sent clients, and overhead expenses were separately used as deductions. The Court of Claims regarded clear reflection of income shown because, in that case, "Where the profits or losses under the foregoing method differed from the correct profits and losses determined on the completion of a contract, compensating adjustments were made upon completion of the work." In the instant case the same situation exists as to compensating adjustments. The petitioner's method necessarily involved adjustment of each contract in the year of completion, for in that year only the remainder of costs expended and the *490 remainder of billings within the contract price showed upon the books. All contracts but two ended in 1937, and in that year adjustments were made to offset insufficient profits or losses taken into 1935 and 1936. Considering such adjustment, the situation is indistinguishable from that in the Hegeman-Harris case. Any deviations from yearly accuracy in reflecting income are offset by the final reconciliation at the end of the contracts, in much the same way as in case of on the permissible completed contract basis. In effect the contracts were in the last year*266 closed on that basis, and reconciliation was made for differences because of previous estimates.
We conclude and hold that the petitioner's method of reporting clearly reflected its income, for both taxable years, that as to 1935 the respondent has failed in his burden of showing otherwise, and therefore of showing that more than 25 percent of properly includible gross income was omitted from the petitioner's return for 1935. Indeed, the Commissioner did not consistently follow his own theory, for he transferred some items, such as on the Pittsburgh Joint Stock Yards contract and the Pennsylvania Railroad account, to other years rather than allocate profit or loss according to ratio of cost. It follows that the statute of limitations on assessment had run at the time of the issuance of the deficiency notice as to the year 1935. For the year 1936, the petitioner had the burden of proof, but it follows from the above that the Commissioner erred in adding to petitioner's income for that year.
There only remains for consideration the question of depreciation claimed in both taxable years, but under our conclusion above as to the statute of limitations, considered here as to 1936 only: *267 The petitioner has the burden of showing erroneous the determination made by the respondent. The only evidence offered was that a graduate civil engineer, long in the petitioner's employ, testified that he was familiar with the company's depreciable equipment, had purchased much of it and used it, was familiar with the ordinary life of depreciable assets and with the depreciation deducted by the petitioner in 1935 and 1936, and from his experience and knowledge of the assets of the petitioner he believed that the 33 1/3 percent depreciation deduction claimed was reasonable and reflected the life of the asset. In our opinion such showing is altogether insufficient to show error in the determination of the Commissioner, and we so hold, with reference to the year 1936.
Decision will be entered under Rule 50.
Footnotes
*. Both petitioner on its books and Commissioner in the deficiency notice treat the two Fort Pitt Bedding Co. contracts as one, uncompleted in 1934.↩
1. SEC. 275. PERIOD OF LIMITATION UPON ASSESSMENT AND COLLECTION.
Except as provided in section 276 --
(a) General Rule. -- The amount of income taxes imposed by this title shall be assessed within three years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period.↩
2. (c) Omission From Gross Income. -- If the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 per centum of the amount of gross income stated in the return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within 5 years after the return was filed.↩
3. SEC. 41. GENERAL RULE.
The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer's annual accounting period is other than a fiscal year as defined in section 48 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year. (For use of inventories, see section 22 (c).)↩