West Constr. Co. v. Commissioner

West Construction Company, Petitioner, v. Commissioner of Internal Revenue, Respondent West Constr. Co. v. Commissioner Docket No. 9605 United States Tax Court 7 T.C. 974; 1946 U.S. Tax Ct. LEXIS 58; October 16, 1946, Promulgated *58 Decision will be entered for the respondent. Advance payments made to petitioner by War Department, pursuant to terms of construction contracts and not evidenced by formal bond, note, mortgage, etc., held, not borrowed invested capital for excess profits tax computation under Internal Revenue Code, section 719. C. Keefe Hurley, Esq., and Samuel S. Dennis, Esq., for the petitioner. Paul P. Lipton, Esq., for the respondent. Opper, Judge. OPPER *974 Petitioner challenges respondent's determination of a deficiency in excess profits tax in the amount of $ 15,266.74 for the taxable year ended December 31, 1943. *975 The sole question presented is whether in computing its excess profits tax credit for the year 1943, based on invested capital, petitioner is entitled to include as borrowed invested capital under Internal Revenue Code, section 719, 50 per cent of the average daily balance of advances made by the United States Government to petitioner in connection with certain war contracts. Some of the facts have been stipulated. FINDINGS OF FACT. The stipulated facts are hereby found accordingly. Petitioner, a Massachusetts corporation, has its principal *59 office in Boston. It filed its excess profits tax return with the collector's office at Seattle for the district of Washington, on or before March 15, 1944. In its excess profits tax return for 1943 petitioner computed its credit under the invested capital method and reported its invested capital as $ 507,517.88. In his notice of deficiency respondent eliminated from invested capital the sum of $ 281,372.87, which represented 50 per cent of the average daily balance of advances to petitioner by the United States Government under the terms of four separate construction contracts entered into between the Government and petitioner. Respondent explained his action thus: Advances made by the Government on war contracts are held not to be borrowed capital within the meaning of section 719 (a) (1) of the Internal Revenue Code. 50% of the interest paid upon these advances is therefore eliminated from income and in the determination of invested capital below these advances have been eliminated as borrowed invested capital. Petitioner performed work under the four contracts in the Alaska area for the War Department during 1943. Each contract was preceded by a letter contract, and the letter*60 contracts and principal contracts were designated and dated, and involved total reimbursable amounts, all as follows: Reimbursable Contract Date amount W-869 -- eng. -- [6917] July1, 1942 $ 4,715,284.72 [9350] Feb.10, 1943 578,767.73 10308 June25, 1943 2,403,783.72 W-45 -- 108 eng. -- [201] Sept. 30, 1943 14,382,632.08 The letter contracts preceding the first three principal contracts contained the following provision: Upon your acceptance hereof, advance payments in accordance with existing requirements of the War Department may be made to you upon your application. Supplemental contracts with respect to the four contracts were entered into shortly after the execution of the principal contracts. *976 Each of the supplemental contracts provided: That the Government would advance money not to exceed a certain percentage of the estimated cost of work done under each contract; that petitioner agreed to pay interest at 2 1/2 per cent per annum on the unliquidated balance of the advanced payments outstanding, the interest being deductible from the fixed fee payable to petitioner; that petitioner would furnish such security as would be required by the*61 Government; that until all advance payments were liquidated, all sums so received, together with all funds received as reimbursement for costs, should be deposited in a special bank account designated so as to indicate clearly its character and purpose, to be used as a revolving fund for carrying out the purposes of the contract and not for petitioner's other business; that the Government was to have a lien on such balances superior to any other person; that repayment of the advances could be made either by crediting reimbursable costs against the unpaid balance due the Government or by cash payment by petitioner, and in event of termination or completion of the contract the unliquidated balance of advance payments could be deducted from any other payments due petitioner, any deficiencies being payable by petitioner in cash. Advance payments under the supplemental agreements were limited to the following percentages of the principal contract price: Contract No. Percentage [50] 10308 12 1/2 [25] Prior to the receipt of any advances petitioner was required to complete the Government standard Form No. 1034, "Public Voucher for Purchases and Services*62 Other Than Personal." The necessary vouchers were signed by petitioner's business manager and duly certified by the Government representative. All advances were evidenced by such vouchers, and attached to the first voucher for initial advances under each contract was a copy of the particular supplemental contract. All funds received as advance payments, together with all funds received as reimbursements for costs or as partial payments, were deposited in separate, special accounts, known as voucher accounts, with the Seattle-First National Bank, Seattle, Washington. Voucher accounts Nos. 2, 3, 4, and 5 were designated as the special accounts and no other funds were therein deposited. Checks on these accounts were signed by petitioner and countersigned by a Government representative. *977 The following amounts, all of which were deposited in the special accounts, were received by petitioner as advances under the four contracts: Contract No. Amount [6917] $ 750,000 [9350] 200,000 10308 475,000 [201] 1,200,000 Petitioner was never refused an advance. The maximum amount which could be advanced in respect to any contract never approached the limit set in any of the*63 supplemental agreements. Prior to April 30, 1943, petitioner's reimbursement requests totaling $ 336,148.01 were used to effect a reduction of the principal amount of advances made under contract No. 6917. The balance was repaid by a check in the amount of $ 163,851.99, dated April 30, 1943, drawn on voucher account No. 2, and a check dated May 10, 1944, in the amount of $ 250,000 drawn on petitioner's general account. All interest due on these advances was discharged by credits against payments at irregular intervals of percentages of the fixed fee due petitioner under the specific contract. The total of $ 200,000 advanced under contract No. 9350, deposited in voucher account No. 3, was repaid by check dated August 5, 1943, drawn on voucher account No. 3. The interest due was paid by check dated August 4, 1943, in the amount of $ 1,226.03, drawn on the same voucher account. The total of $ 475,000, deposited in voucher account No. 4, was repaid by checks drawn on that voucher account on various dates in 1944. On March 20, 1944, all interest due was paid by crediting it against the first estimate of the percentage of fixed fee due petitioner under the specific contract. Of the *64 total of $ 1,200,000, $ 400,000 was paid petitioner prior to December 31, 1943, and was deposited in voucher account No. 5. $ 400,000 was repaid by checks, drawn during 1944 and 1945, on voucher account No. 5. The interest due on December 31, 1943, was paid on February 4, 1944, by crediting the amount due against payment of the percentage of the fixed fee found to be due petitioner under the specific contract. Petitioner treated the advances made by the Government as liabilities, reporting them under item 10 (a), "Bonds, notes, and mortgages payable: (a) with original maturity of less than 1 year" of schedule L, "Balance Sheets," on Form 1120. Petitioner at no time executed any bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust in *978 respect of any of the amounts advanced to it by the United States Government. OPINION. Laying aside other statutory conditions, this petitioner can not succeed unless the "indebtedness" it ran up in favor of the Government was evidenced by a "bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust." Only such debts are permissible inclusions to any extent in*65 "equity invested capital" for excess profits tax purposes. 1 When petitioner, working on War Department contracts, was granted credits by the Government in excess of amounts presently due it under the contracts, it executed no document technically answering to the statutory description. See Journal Publishing Co., 3 T. C. 518. It is hence permissible to inquire whether its situation nevertheless falls within the purpose and scope of the legislation in order to ascertain whether the lawmakers intended to embrace such arrangements as the present one. See Aetna Oil Co. v. Glenn (Dist. Ct., W. Dist. Ky.), 53 Fed. Supp. 961.*66 Several considerations lead to the conclusion that the provision in question does not apply to petitioner. Underlying the whole plan of the statute is the assumption that invested capital may consist, not only of equity interests typically represented by stock, but of borrowed capital as well. Internal Revenue Code, secs. 717-719. But it is equally reasonable to infer that what was intended was an investment as to which the business in question assumes some risk. We must never lose sight of the fundamental purpose of the legislation, which was to establish a measure by which the amount of profits which were "excess" could be judged. Thus, capital funds placed at the risk of the business might be regarded as entitled to an adequate return. See Economy Savings & Loan Co., 5 T. C. 543. But other items, not contributed by those participating in the venture and not in the nature of capital employed, were to be excluded. We find in this concept an explanation of the restrictive character of the permissible evidence with which Congress surrounded the provision, and also of its plainly intentional omission of the phrase "or similar evidences of indebtedness" *67 appearing in the original committee report on the section. Flint Nortown Theatre Co., 4 T. C. 536. Added to this is the assistance to be derived from the provision dealing with those having foreign government contracts. The original version of section 719 (a) was, as petitioner asserts, enacted in 1940, prior *979 to the entry of the United States into the war. But it was amended in 1942 (Revenue Act of 1942, sec. 205 (e)), without change in subsection (2), which limits the includible portion of "advance payments" as follows: (2) In the case of a taxpayer having a contract (made before the expiration of 30 days after the date [Oct. 8, 1940] of the enactment of the Second Revenue Act of 1940) with a foreign government to furnish articles, materials, or supplies to such foreign government, if such contract provides for advance payment and for repayment by the vendor of any part of such advance payment upon cancellation of the contract by such foreign government, the amount [of borrowed capital shall include the amount] which would be required to be so repaid if cancellation occurred at the beginning of such day * * *. This provision suggests three*68 propositions: First, that in the legislative view "advance payments" would not be includible at all in the absence of specific language, as otherwise the whole paragraph would have been unnecessary, see Gilbert v. Commissioner (C. C. A., 1st Cir.) 56 Fed. (2d) 361, 362; second, that under the "expressio unius" rule relief in "advance payment" cases was intended to be confined to contracts made prior to the passage of the original legislation (or 30 days thereafter), see Botany Worsted Mills v. United States, 278 U.S. 282, presumably on the theory that it should not apply adversely to contracts already in existence or in immediate prospect; and, third, that it was never extended in any form to contracts with our own Government. This last element is perhaps best explained by an expansion of petitioner's reasoning. It points out that in 1940 war contracts were generally confined to foreign governments, since the rearmament program of the United States had then scarcely begun. To this we may add that such was not the case in 1942, when the section was again considered. But at all times the portion with which*69 we are presently concerned was confined to pre-1941 contracts. There being none of consequence with our own Government, the original form of the provision sufficed on both dates. But, whatever the explanation, the fact remains that inclusion in borrowed capital of advance payments was limited both to pre-1941 contracts and to those made with foreign governments. Looking now to the transactions between petitioner and the War Department, there seems little question that they fell into the general class with which this provision purported to deal. The language of both the relevant documents and the applicable regulations characterize the amounts in question as "advance payments." Granting that they may in some degree have aspects of indebtedness, they were carefully distinguished from ordinary loans, 2 at least to a sufficient *980 extent to justify the application here of what we conceive to be the congressional purpose in dealing specifically with advance payments as such. Even the statutory reference to a provision "for advance payment and for repayment by the vendor of any part of such advance payment upon cancellation of the contract" is apt. It seems manifest that had*70 section 719 (a) (2) been applied to post-1940 contracts with this Government, it would have included petitioner's case with neat precision. The converse can not but be equally true. Taking the view that it was not within the legislative purpose to include the type of relationship here in controversy in the catalogue of transactions which could give rise to the existence of borrowed capital for purposes of section 719, we find no error in the contested deficiency. *71 Decision will be entered for the respondent. Footnotes 1. SEC. 719. BORROWED INVESTED CAPITAL. (a) Borrowed Capital. -- The borrowed capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following: (1) The amount of the outstanding indebtedness (not including interest) of the taxpayer which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust, * * *↩ 2. Cf. Executive Order No. 9001 (6 F. R. 6787), approved December 18, 1941, authorizing advance, progress and other payments," with Executive Order No. 9112 (7 F. R. 2367), approved March 26, 1942, authorizing guarantees of or participation in "loans, discounts, or advances" by financing institutions; see also War Dept. Procurement Reg. No. 3 (10 C. F. R. Cum. Supp., pp. 3284, et seq.); para. 320 "Guarantees, loans, and commitments under Executive Order No. 9112↩" and para. 321 "Advance payments."