Standard Hosiery Mills, Inc. v. Commissioner

Standard Hosiery Mills, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Standard Hosiery Mills, Inc. v. Commissioner Docket No. 28954 United States Tax Court 27 T.C. 525; 1956 U.S. Tax Ct. LEXIS 12; December 18, 1956, Filed *12 Decision will be entered under Rule 50. Respondent determined a constructive average base period net income (CABPNI) under section 722, I. R. C. 1939, for petitioner's taxable year ended October 31, 1941. He mailed a statutory notice under section 732 for that year on January 16, 1945, and advised petitioner that its application for relief was allowed in part. No petition was filed. On August 29, 1945, petitioner wrote respondent a letter inquiring whether the statutory notice was such a final determination as would permit the use of such CABPNI in all its subsequent returns. On September 24, 1945, respondent replied that the CABPNI for fiscal 1941 was "finally determined" on April 16, 1945, and that its use was confined to any return required after April 16, 1945, but that its use could not be permitted in any return required prior thereto. In 1947 petitioner moved its offices and because of lack of space it destroyed some of the records pertaining to 1941 and earlier years. On March 15, 1950, respondent mailed a statutory notice under section 732 for the taxable years ended October 31, 1942, 1943, 1944, and 1945, and advised petitioner that "you have not established your*13 right to the relief requested in your applications" for those years. Held, respondent is not precluded, nor is he estopped, from determining that petitioner is not entitled to relief under section 722 for the taxable years ended October 31, 1942, 1943, 1944, and 1945. Jacquin D. Bierman, Esq., and Richard S. Helstein, C. P. A., for the petitioner. Martin D. Cohen, Esq., for the respondent. Arundell, Judge. ARUNDELL *525 Respondent determined deficiencies*14 in income and excess profits taxes and disallowed claims for refund of excess profits tax asserted in applications for relief under section 722, Internal Revenue Code of 1939, as amended, for years and in amounts as follows: Deficiency Deficiency Refund Fiscal year ended October 31 income tax excess profits claims tax disallowed [1942] $ 4,313.40 $ 36,380.64 $ 149,088.86 [1943] 102,483.74 149,860.03 [1944] 115,312.91 155,666.80 [1945] 74,765.43 133,520.37 The only issue remaining is whether respondent is precluded, as a matter of law, from determining that petitioner is not entitled to relief under section 722 for all or any of the taxable years mentioned above. The parties have stipulated that if this Court holds as a matter of law that respondent is so precluded, then in computing petitioner's excess profits tax liabilities for the above-mentioned taxable years petitioner is entitled to use an excess profits credit based on a constructive *526 average base period net income in the amount of $ 209,330.72; and that if this Court holds as a matter of law that respondent is not so precluded, then this Court may find: (a) that in the computation*15 of petitioner's excess profits tax liabilities for the taxable years ended October 31, 1942, 1943, 1944 and 1945, petitioner's excess profits credits are in the respective amounts set forth in paragraphs 19, 20, 21 and 22 of Stipulation No. 2 filed simultaneously herewith and (b) that petitioner is not entitled to any relief under Section 722 of the Internal Revenue Code of 1939 for such years. The parties have further stipulated that whatever our decision may be with regard to the above-mentioned issue of law, effect shall be given in a computation under Rule 50 to the adjustments agreed to by the parties and fully set forth in Stipulation No. 2. FINDINGS OF FACT. Stipulation Nos. 1, 2, and 3, together with all the exhibits submitted therewith, are incorporated herein by this reference. Petitioner is a corporation organized in 1928 under the laws of the State of North Carolina. It filed its returns for the periods here involved with the then collector of internal revenue for the district of North Carolina at Greensboro. On July 14, 1942, petitioner filed Form 991, application for relief under section 722, 1 for its taxable year ended October 31, 1941. *16 On January 9, 1943, respondent transmitted to petitioner a revenue agent's report dated November 17, 1942, covering the fiscal years ended October 31, 1940 and 1941. This report determined, among other things, that petitioner qualified for relief under section 722, and also determined the constructive average base period net income to be used as the basis of petitioner's excess profits credit for its taxable year ended October 31, 1941. The net result of the report for the taxable year ended October 31, 1941, was an overassessment of excess profits tax in the amount of $ 19,368.30 for that year. On or about April 26, 1943, petitioner received from the Treasury Department a check for $ 20,033.44, which represented a refund of excess profits tax in the amount of $ 19,368.30, with interest thereon, for the taxable year ended October 31, 1941, determined according to the revenue agent's report transmitted to petitioner on January 9, 1943. On January 15, 1943, petitioner filed its income and excess profits tax returns for its taxable year ended October 31, 1942. The computation of its excess profits credit on its excess profits tax return did not take into account any constructive average*17 base period net income under section 722. *527 On August 6, 1943, petitioner filed an application for relief under section 722, Form 991, for its taxable year ended October 31, 1942, and an amended application on May 14, 1948. It also filed a claim for refund under section 722 on Form 843 for the same year on August 11, 1947. These claims were timely filed. On January 20, 1944, petitioner filed its income and excess profits tax returns for its taxable year ended October 31, 1943. In the computation of its excess profits credit on its excess profits tax return, petitioner used the constructive average base period net income determined in the revenue agent's report for the taxable year ended October 31, 1941, as adjusted under section 711 (b). On December 19, 1945, petitioner filed an application for relief under section 722, Form 991, for its taxable year ended October 31, 1943, and an amended application on June 7, 1948. These claims were timely filed. On January 16, 1945, respondent mailed to petitioner a statutory notice under section 732 notifying petitioner of the partial allowance of its claim for relief under section 722 for the taxable year ended October 31, 1941, *18 and that an overassessment of $ 19,368.30 for that year had been made the subject of a certificate of overassessment previously forwarded to petitioner. Petitioner did not file a petition with this Court and after 90 days, namely, on April 16, 1945, respondent's determination for the taxable year ended October 31, 1941, became a final determination. On February 16, 1945, petitioner filed its income and excess profits tax returns for its taxable year ended October 31, 1944. In the computation of its excess profits credit on its excess profits tax return, petitioner used the constructive average base period net income determined in the revenue agent's report for the taxable year ended October 31, 1941, as adjusted under section 711 (b). On August 29, 1945, petitioner's then representative addressed a letter to respondent, the fifth paragraph 2 of which is as follows: The question now arises as to whether the determination of the constructive average base period net income, as used in connection with the redetermination of this taxpayer's excess-profits tax liability for its fiscal year ended October 31, 1941, under the provisions of Section 722 of the Code, and as communicated to *19 the taxpayer by the office of the Internal Revenue Agent in Charge on January 9, 1943, formally accepted by the taxpayer, who executed Form 874 on November 17, 1942, and approved by the Commissioner, as shown by the Bureau's statutory notice of January 16, 1945, in [sic] such a final determination as is contemplated by Mimeograph 5895, dated July 17, 1945, and will clearly permit the taxpayer to use the same constructive average base period earnings in computing *528 its excess-profits taxes in all of its subsequent returns, subject, of course, to such further adjustments as may be required by Section 711 (b) of the Code. On September 24, 1945, respondent, in answer to petitioner's letter of August 29, *20 1945, advised petitioner in the last paragraph of his letter as follows: Accordingly, since the statutory notice was issued January 16, 1945, and the taxpayer decided not to file a petition with The Tax Court of the United States, the constructive average base period net income determined for the taxable year ended October 31, 1941 was finally determined at the expiration of the ninety-day period from the date of the statutory notice or April 16, 1945. Therefore the use of the constructive average base period net income, determined for the year ended October 31, 1941 is confined to any return required subsequent to the date of final determination or after April 16, 1945. The taxpayer is not permitted to use the same constructive average base period net income in computing its excess profits taxes in the returns required prior thereto without the filing of an application for relief under section 722 for each taxable year for which such relief is claimed. On December 19, 1945, petitioner filed an application for relief under section 722, Form 991, for its taxable year ended October 31, 1944, and an amended application on May 14, 1948. These claims were timely filed. On January 16, *21 1946, petitioner filed its income and excess profits tax returns for its taxable year ended October 31, 1945. In the computation of its excess profits credit on its excess profits tax return, petitioner, pursuant to the express permission granted by respondent in his above-mentioned letter dated September 24, 1945, used the constructive average base period net income determined in the revenue agent's report for the taxable year ended October 31, 1941, as adjusted under section 711 (b). On May 14, 1948, petitioner timely filed an application for relief under section 722, Form 991, for its taxable year ended October 31, 1945. Petitioner's president and general manager, John Shoffner, died on March 3, 1944. Pursuant to resolutions of petitioner's stockholders and board of directors under dates of May 22, 23, and 24, 1944, a plan of reorganization, by recapitalization, was adopted and agreed upon, whereby all of the then issued and outstanding stock of petitioner was exchanged for new preferred shares, and petitioner's new management, Chester H. Roth Co., Inc., acquired all of petitioner's newly issued voting stock for $ 200,000 in cash. In connection with this reorganization, a nationally*22 known firm of certified public accountants was engaged to prepare a report of petitioner's financial condition as of June 3, 1944. In this report, which was submitted to petitioner on August 2, 1944, the accountants included as an asset in petitioner's balance sheet as of June 3, 1944, the amount of $ 30,798.67 as representing "claim for refund of excess profits tax for fiscal *529 year ended October 31, 1942, under Sec. 722" which they explained in note B as follows: The Company filed claim for refund of excess profits tax under general relief Section 722 for the fiscal year ended October 31, 1941. The claim was allowed and refund made in substantially the amount claimed. Claim for refund for the year ended October 31, 1942, was made on the same basis, and the amount thereof, adjusted for corresponding difference in normal tax and surtax, is carried among Investments and Other Assets in the balance sheet. In the excess profits tax return for the year ended October 31, 1943, the excess profits credit was computed upon the constructive basis as allowed for 1941 and claimed for 1942. On March 17, 1948, respondent transmitted to petitioner a revenue agent's report dated February*23 5, 1948, covering the taxable years ended October 31, 1942, 1943, 1944, and 1945, in which report it was recommended that petitioner's claims for relief under section 722 for those years be rejected. On December 23, 1949, the Excess Profits Tax Council advised petitioner's then representative by letter that "Although the taxpayer qualifies for consideration for relief under section 722 (b) (4) with respect to its increase in capacity and related changes in operations effected in the base period, the taxpayer has not established that its statutory average base period net income * * * is an inadequate standard of its normal earnings within the purview of section 722" and that its claims for relief under section 722 for the taxable years ended October 31, 1942, to October 31, 1945, inclusive, should be disallowed in full. The statutory notice covering the taxable years ended October 31, 1942, 1943, 1944, and 1945, was mailed to petitioner on March 15, 1950. In this notice, respondent stated "it has been determined that you have not established your right to the relief requested in your applications" and in a "statement" attached to the notice respondent also stated "it is held that *24 you failed to qualify for relief under the provisions of section 722 of the Internal Revenue Code" of 1939. At the time of the reorganization in 1944 and for many years prior thereto, petitioner's records were kept in Alamance, North Carolina. They consisted of the general ledger, purchase journals, sales journals, payroll records, cost and production records, certain supplemental records for factory information and production, and certain sales records relating to the distribution of the manufactured product. Some of these records went back to the year 1929. Norman A. Jackson became treasurer of petitioner in May 1944, and from then on was in charge of the company's records. As treasurer, Jackson made himself fully acquainted with all the relief claims filed by petitioner under section 722. Petitioner had a policy of eliminating certain records for prior years where the tax liability for such years had been finally determined. *530 In 1947, petitioner moved its offices from Alamance to a new building in Burlington, North Carolina. Because of a shortage of space in the new building, Jackson ordered the personnel to destroy most of the records for 1941 and prior years except*25 the general ledger, the purchase journals, and the sales journals. Because of this destruction, petitioner found itself handicapped in furnishing information in support of its claims for relief for the years 1942 to 1945, inclusive. Petitioner is not entitled to any relief under section 722 for any of the taxable years ended October 31, 1942, 1943, 1944, and 1945. In the computation of petitioner's excess profits tax liabilities for the taxable years ended October 31, 1942, 1943, 1944, and 1945, petitioner's excess profits credits, as determined under the income method, are in the respective amounts of $ 138,578.84, $ 138,578.84, $ 133,204.25, and $ 125,472.95. OPINION. Petitioner contends that the legislative and administrative history of section 722 establishes its right, as a matter of law, to use the constructive average base period net income finally determined for the year ended October 31, 1941, as adjusted 3 under section 711 (b), in computing its excess profits taxes for all subsequent years; that this contention is consistent with respondent's regulations on the subject; and that, in any event, respondent is estopped from reconsidering his determination of constructive*26 average base period net income for the taxable year ended October 31, 1941, with respect to all subsequent years. Section 722 originally consisted of but one sentence. It had its appearance in "Subchapter E -- Excess Profits Tax," which subchapter was inserted in the Internal Revenue Code of 1939 by section 201 of the Second Revenue Act of 1940, approved October 8, 1940. On March 7, 1941, it was amended by section 6 of the Excess Profits Tax Amendments of 1941 so as to consist of 5 subsections, (a) to (e), inclusive. We need not dwell longer on this early history of section 722 or to consider the regulations 4 approved thereunder for the reason that section 722 was later amended by section 222 of the Revenue Act *27 of 1942, approved October 21, 1942, which amendments to section 722 as provided in section 222 (e) "shall be applicable with respect to taxable years beginning after December 31, 1939." *531 Section 722 (d), as amended by section 222 of the Revenue Act of 1942, provided in part as follows: (d) Application for Relief Under This Section. -- The taxpayer shall compute its tax, file its return, and pay its tax under this subchapter without the application of this section * * *. The benefits of this section shall not be allowed unless the taxpayer * * * makes application therefor in accordance with regulations to be prescribed by the Commissioner with the approval of the Secretary * * *. If a constructive average base period net income*28 has been determined under the provisions of this section for any taxable year, the Commissioner may, by regulations approved by the Secretary, prescribe the extent to which the limitations prescribed by this subsection may be waived for the purpose of determining the tax under this subchapter for a subsequent taxable year. The first regulation on the above section 722 (d) was section 30.722-5 (e) of Regulations 109 contained in T. D. 5264 (1943 C. B. 761, 764, 791) approved May 8, 1943, the material part of which provided: (e) Waiver of limitations for subsequent taxable years. -- If constructive average base period net income is finally determined under section 722 (a) with respect to a taxpayer, * * * and if, in the opinion of the Commissioner, no substantial evidence exists which requires a redetermination of such constructive average base period net income for use in any subsequent taxable year, such taxpayer may without the filing of any application on Form 991 (revised January, 1943) use the constructive average base period net income so determined, except as further adjustments may be required by section 711 (b), in computing*29 its excess profits credit based on income and its excess profits tax in any return required to be filed thereafter. * * * Eligibility for relief and a constructive average base period net income finally determined on behalf of a taxpayer with respect to an excess profits tax taxable year may have to be reestablished with respect to a subsequent taxable year if: [Note: Here are listed six specific fact situations, any one of which, if present, would require the reestablishment of the constructive average base period net income. However, in the instant case, not any of the listed fact situations is present.] On December 17, 1943, Public Law 201, 78th Cong., 1st Sess., was approved. This Public Law amended section 722 (d)5 but the amendments are not material in so far as our present problem is concerned. *30 On January 25, 1944, Regulations 112, relating to the excess profits tax under the 1939 Code, as amended, were approved. These regulations *532 are applicable only to taxable years beginning after December 31, 1941. On July 21, 1944, T. D. 5393 (1944 C. B. 415) was approved. See paragraphs 5, 6, 11, and 12 of this Treasury Decision, wherein certain sections of Regulations 109 and 112 are stricken out, renumbered, and amended, so that sections 30.722-5 (d) of Regulations 109 and 35.722-5 (d) of Regulations 112, both identically provide, in part, as follows: (d) Waiver of limitations for subsequent taxable years. -- The taxpayer shall file an application for relief under section 722 for each taxable year for which such relief is claimed, regardless of whether a constructive average base period net income has been determined with respect to such taxpayer for a prior taxable year. However, if a constructive average base period net income has been finally determined under section 722 (a) with respect to the taxpayer * * *, such taxpayer may use the constructive average base period net income so determined, except as further*31 adjustments may be required by section 711 (b), in computing its excess profits credit based on income, its adjusted excess profits net income, and its excess profits tax in any return required to be filed thereafter. If the taxpayer is of the opinion 6*32 that, by virtue of a change in the factors upon the basis of which relief has been determined for a prior taxable year, it is entitled to a constructive average base period net income in a subsequent taxable year in an amount less than that previously determined, it may use such smaller amount as a constructive average base period net income in computing its excess profits tax on its return filed for such subsequent year. If upon examination of a return in which the taxpayer, in accordance with the two preceding sentences, has used, in whole or in part, a constructive average base period net income previously determined, the Commissioner may, if the facts in the case warrant such action, determine that for the taxable year no constructive average base period net income under section 722 is allowable or that a constructive average base period net income is allowable in a different amount. 7 Petitioner, in support of its contention that the legislative and administrative history of section 722 establishes its right, as a matter of law, to use the constructive average base period net income finally determined for the year ended October 31, 1941, relies heavily upon a statement 8 made in Conference Report No. 2586, 77th Cong., 2d Sess. (1942-2 C. B. 701, 721) which accompanied the Revenue Bill of 1942 *533 (H. R. 7378). What we think Congress intended was that if a constructive average base period net income had been finally determined administratively for any taxable year, the Commissioner, by proper regulations, might administratively*33 permit the use of such constructive average base period net income in the computation of the tax shown on the return for a subsequent taxable year. We do not think Congress ever intended that once a constructive average base period net income had been finally determined administratively for a given year, petitioner, upon such final determination, acquired a substantive right in such constructive average base period net income for all future taxable years. Such a construction of the statute would perpetuate any error that might have been made either in favor of the taxpayer or against the taxpayer in the administrative determination for the earlier year, and would for later years make meaningless the provision contained in section 732 for a "redetermination" by this Court. *34 We are, therefore, of the opinion that, except where the prior final determination is one made by this Court, thereby introducing the doctrine of res judicata and/or collateral estoppel, 9 the respondent may, under the above-mentioned regulations, make an administrative redetermination of the constructive average base period net income for any subsequent year "if the facts in the case warrant such action." The respondent no doubt was of the opinion that the facts in the instant case did warrant a redetermination of the constructive average base period net income for subsequent years, for in the statutory notice mailed to petitioner on March 15, 1950, he stated "it has been determined that you have not established your right to the relief requested in your applications." Notwithstanding petitioner's contention to the contrary, this determination is presumed to be correct and the burden of disproving it is upon petitioner. See Rule 32 of the Tax Court Rules of Practice, and Avery v. Commissioner, (C. A. 5, 1927) 22 F. 2d 6. *35 Petitioner contends, however, that it relied to its detriment upon representations made by respondent in his letter to petitioner dated September 24, 1945, and that as a result thereof respondent is estopped for the years ended October 31, 1942, 1943, 1944, and 1945, from reconsidering his prior determination of constructive average base period net income. It is true respondent advised petitioner that in filing its return for 1945 the constructive average base period net income as theretofore determined for 1941 could be used, and petitioner did in fact use the constructive average base period net income so determined *534 for the earlier year. But, as we have already pointed out, the right to so make a return did not confer on petitioner substantive rights of a nature that would prevent the respondent from correcting in years subsequent to 1941 what he regarded as an error in his earlier determination. It may be noted that the special right to use the 1941 constructive average base period net income in computing the tax in later returns had no application to the returns for the years 1942, 1943, and 1944, for which years petitioner was required to file claims for relief under*36 section 722 just as it had done for 1941. In our opinion, there is no basis for the application of the principle of equitable estoppel in this case and the fact that petitioner may have destroyed some of its records that may be helpful in making proof does not change the situation. We think petitioner's argument on this point is without merit. Reviewed by the Special Division. Decision will be entered under Rule 50. Footnotes 1. All references to section numbers herein are to the Internal Revenue Code of 1939, as amended, unless otherwise designated.↩ 2. The citation of Mimeograph 5895 referred to in this paragraph is 1945 C. B. 276. The headnote of this mimeograph reads as follows: "Date on which constructive average base period net income has been finally determined within meaning of section 35.722-5 (d↩) of Regulations 112." 3. This adjustment is for income taxes for the base period years and is automatic due to the repeal of section 711 (b) (1) (A) by section 202 (c) (2) of the Revenue Act of 1941, effective under section 205, 1941 Act, with respect to taxable years beginning after December 31, 1940, and is not in dispute.↩ 4. The original Regulations 109 were published as T. D. 5037 (1941-1 C. B. 117, 153) and were amended by T. D. 5045 (1941-1 C. B. 69↩, 70, 102) to conform to the Excess Profits Tax Amendments of 1941. 5. Section 722 (d), as amended by Pub. L. 201, provides: (d) Application for Relief Under This Section. -- The taxpayer shall compute its tax, file its return, and pay the tax shown on its return under this subchapter without the application of this section, except as provided in section 710 (a) (5). The benefits of this section shall not be allowed unless the taxpayer within the period of time prescribed by section 322 and subject to the limitation as to amount of credit or refund prescribed in such section makes application therefor in accordance with regulations prescribed by the Commissioner with the approval of the Secretary. If a constructive average base period net income has been determined under the provisions of this section for any taxable year, the Commissioner may, by regulations approved by the Secretary, prescribe the extent to which the limitations prescribed by this subsection may be waived for the purpose of determining the tax under this subchapter for a subsequent taxable year.↩ 6. It is conceded that at no time was petitioner of such an "opinion" as is referred to in this regulation.↩ 7. The remainder of sections 30.722-5 (d) of Regulations 109 and 35.722-5 (d↩) of Regulations 112 dealt with matter with which we are not here concerned, and with the kind of facts, which, if they existed, might, under the regulations, require a redetermination of a constructive average base period net income for use in any subsequent taxable year. Petitioner has established that no such facts exist in the instant case. 8. The Conference Report reads in part as follows: "Under the existing law, as interpreted by the Commissioner of Internal Revenue, it was necessary for the taxpayer to compute his [sic↩] tax without regard to the relief provisions and file a claim for refund for each taxable year. It is believed that such a procedure should not be followed where the taxpayer has had its constructive average base period net income finally determined for any year. Such determination should permit the taxpayer to use the base period net income so determined as a basis in computing its excess profits tax for any future year." 9. Cf. George Kemp Real Estate Co., 17 T. C. 755, affd. (C. A. 2, 1953) 205 F. 2d 236, certiorari denied 346 U.S. 876; Jacob's Fork Pocahontas Coal Co., 24 T. C. 60; and Stern & Stern Textiles, Inc., 26 T. C. 1000↩.