Mullaly v. Commissioner

Carter Mullaly, George A. Hales and James R. McBrayer, as Trustees of Hales-Mullaly, Inc., a Dissolved Corporation, Petitioners, v. Commissioner of Internal Revenue, Respondent Mullaly v. Commissioner Docket No. 5948 United States Tax Court 5 T.C. 1376; 1945 U.S. Tax Ct. LEXIS 6; December 29, 1945, Promulgated *6 Decision will be entered under Rule 50. Petitioner computed its excess profits credit for the fiscal year ended August 31, 1941, under section 713 of the Internal Revenue Code. Respondent revised petitioner's excess profits tax net income for two base period years by disallowing a portion of certain advertising and publicity expenses for those years as abnormal deductions under section 711 (b) (1) (J) of the code. Petitioner did not elect to charge to capital account any part of its expenditures for advertising and promotion of good will in those years and has not sought to revise its excess profits net income for the base period years by revising its deductions for advertising and publicity purposes under the provisions of section 711 (b) (1) (J) and (K). Held, that section 711 (b) (1) (J) is a relief provision for the exclusive benefit of taxpayers and that respondent is without authority to revise the excess profits tax net income for the base period years in accordance therewith when the application of such section has not been invoked by the taxpayer as provided in subsection (K) (ii). Charles H. Garnett, Esq., for the petitioners. James L. Backstrom, Esq., for the respondent. Hill, Judge. HILL *1377 This proceeding involves excess profits tax for the fiscal year ended August 31, 1941. The petitioners are the trustees of Hales-Mullaly, Inc., a dissolved corporation, and as such are authorized to bring this action. For convenience the corporation will be referred to herein as petitioner. The Commissioner determined a deficiency in the sum of $ 966.32, and petitioner claims an overpayment of $ 209.66. Some of the facts have been stipulated and are so found. Facts found other than those stipulated are from the evidence submitted at the hearing. FINDINGS OF FACT. The petitioners are the trustees of Hales-Mullaly, Inc., an Oklahoma corporation, which was dissolved March 28, 1944. As trustees they are authorized to bring this action on behalf of the corporation. The income tax returns for *8 the year in question were filed with the collector of internal revenue for the district of Oklahoma. At all times under discussion, petitioner's business was that of wholesale distributor of certain household appliances. As distributor, petitioner's function was to promote the distribution and sale of various lines of household appliances by developing merchandising techniques, training salesmen, and supervising service departments and generally to control and supervise the operations of dealers in connection with a particular line of merchandise. The gross sales of petitioner for the fiscal years set out below are as follows: Year ended Aug. 31, 1936 $ 1,391,410.64 [1937] 1,581,891.92 [1938] 1,136,799.92 [1939] 1,068,067.60 [1940] 920,584.11 During those years petitioner spent the following amounts for advertising and the promotion of good will: Year ended Aug. 31, 1936 $ 45,310.31 [1937] 67,390.46 [1938] 98,527.91 [1939] 35,041.85 [1940] 31,777.37 These advertising, publicity, and promotion expenses were claimed as deductions on petitioner's tax returns for each of the fiscal years ended August 31, 1936 to 1940, inclusive, and were allowed by respondent in computing*9 petitioner's net income for those years. No attempt was made by petitioner or respondent to adjust these deductions until respondent determined the deficiency in excess profits tax for the fiscal year ended August 31, 1941. *1378 The adjusted excess profits net income for petitioner for the four years preceding the fiscal year ended August 31, 1941, prior to the adjustments made by the Commissioner complained of herein, are as follows: Year ended Aug. 31, 1937 $ 59,537.30 1938 (loss) (64,195.27) [1939] 7,962.99 [1940] 40,836.89 Petitioner did not elect to charge to capital account any part of its expenditures for advertising or promotion of good will in any of these years. Petitioner computed its excess profits credit for the fiscal year ended August 31, 1941, under section 713 of the Internal Revenue Code. At no time herein has petitioner sought to revise, in any way, its excess profits net income for any of the fiscal years ended August 31, 1937 to 1940, inclusive, by revising its deductions for advertising, publicity, and promotion, or otherwise, under the provisions of section 711 (b) (1) (J) and (K) of the code. The respondent determined that in computing*10 the excess profits credit for the fiscal year ended August 31, 1941, deductions claimed for advertising and publicity expense for the fiscal years ended August 31, 1937, and August 31, 1938, in the respective amounts of $ 1,560.01 and $ 42,427.91, should be disallowed as being abnormal in amount in accordance with the provisions of section 711 (b) (1) (J) (ii) of the code. The deficiency herein resulted from such disallowance. OPINION. Respondent, on his own initiative, revised petitioner's net income for the taxable years ended August 31, 1937 and 1938, by disallowing a portion of certain advertising and publicity expenses for those years as abnormal deductions under section 711 (b) (1) (J) (ii) of the Internal Revenue Code. 1*13 This revision in petitioner's net *1379 income for these base period years reduced its excess profits credit in the year 1941 and resulted in the deficiency. It is stipulated that petitioner did not elect to capitalize these expenses under section 733 of the Code. 2*14 Petitioner concedes that if respondent has the authority to take the action complained of, the amounts disallowed are correct. Petitioner challenges respondent's determination on several*11 grounds. First, petitioner contends that section 711 (b) (1) (J) is a relief provision which only a taxpayer can invoke; that petitioner has not invoked it and, hence, the provision is not applicable here. This contention of petitioner is based on section 711 (b) (1) (K) (ii) of the code. 3 Petitioner further contends that, in any event, the increase in advertising and publicity expenses in 1937 was due to an increase in its gross income for that year and that in the taxable year 1938 it was due to a change in the size and condition of petitioner's business and no adjustment is necessary because the expenses were not abnormal. Respondent agrees that the cited section is a relief provision, but contends that it is for the benefit of both the taxpayer and the Government and that nowhere in the Internal Revenue Code can be found a bar to his authority to make the adjustment in question. In Colson Corporation, 5 T. C. 1035, we decided the identical question here involved in favor of the contention of the taxpayer in that case. We adhere to our decision in that case, and on the authority thereof we *1380 sustain petitioner in its first contention*12 hereinabove set forth. It is unnecessary therefore to give consideration to petitioner's further and alternative contention hereinabove set forth. We hold that there is no deficiency, but in view of the fact that petitioner claims an overpayment, Decision will be entered under Rule 50. Footnotes 1. SEC. 711. EXCESS PROFITS NET INCOME. * * * * (b) Taxable Years in Base Period. -- (1) General rule and adjustments. -- The excess profits net income for any taxable year subject to the Revenue Act of 1936 shall be the normal-tax net income, as defined in section 13 (a) of such Act; and for any other taxable year beginning after December 31, 1937, and before January 1, 1940, shall be the special-class net income as defined in section 14 (a) of the applicable revenue law. In either case the following adjustments shall be made * * *; * * * * (J) Abnormal Deductions. -- Under regulations prescribed by the Commissioner, with the approval of the Secretary, for the determination, for the purposes of this subparagraph, of the classification of deductions -- * * * * (ii) If the class of deductions was normal for the taxpayer, but the deductions of such class were in excess of 125 per centum of the average amount of deductions of such class for the four previous taxable years, they shall be disallowed in an amount equal to such excess.↩ 2. SEC. 733. CAPITALIZATION OF ADVERTISING, ETC., EXPENDITURES. (a) Election to Charge to Capital Account. -- For the purpose of computing the excess profits credit, a taxpayer may elect, within six months after the date prescribed by law for filing its return for its first taxable year under this subchapter, to charge to capital account so much of the deductions for taxable years in its applicable base period on account of expenditures for advertising or the promotion of good will, as, under rules and regulations prescribed by the Commissioner with the approval of the Secretary, may be regarded as capital investments. Such election must be the same for all such taxable years, and must be for the total amount of such expenditures which may be so regarded as capital investments. In computing the excess profits credit, no amount on account of such expenditures shall be charged to capital account: (1) For taxable years in the base period unless the election authorized in subsection (a) is exercised, or (2) For any taxable year prior to the beginning of the base period. (b) Effect of Election. -- If the taxpayer exercises the election authorized under subsection (a) -- (1) The net income for each taxable year in the base period shall be considered to be the net income computed with such deductions disallowed, and such deductions shall not be considered as having diminished earnings and profits. This paragraph shall be retroactively applied as if it were a part of the law applicable to each taxable year in the base period; * * *↩ 3. SEC. 711. * * * * * * * (K) Rules for Application of Subparagraphs (H), (I), and (J). -- For the purposes of subparagraphs (H), (I), and (J) -- * * * * (ii) Deductions shall not be disallowed under such subparagraphs unless the taxpayer establishes that the abnormality or excess is not a consequence of an increase in the gross income of the taxpayer in its base period or a decrease in the amount of some other deduction in its base period, and is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer.↩