Capital Warehouse Co. v. Commissioner

Capital Warehouse Co., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Capital Warehouse Co. v. Commissioner Docket No. 12178 United States Tax Court 9 T.C. 966; 1947 U.S. Tax Ct. LEXIS 31; November 24, 1947, Promulgated *31 Decision will be entered under Rule 50. Respondent's determination that a public warehouse company keeping its books and filing its returns on the accrual basis could not, during the first two years of its existence, exclude from its income that portion thereof which the company set aside in a reserve account as its contractual liability to remove goods from its warehouse at the end of the storage period, held to be justified by section 41, I. R. C. J. S. Delehanty, Esq., and Dennis D. Daly, Esq., for the petitioner. T. A. Steele, Jr., Esq., for the respondent. Harlan, Judge. HARLAN *966 The respondent determined the following deficiencies for the taxable years of the petitioner ended May 31, 1943 and 1944: *967 Declared Year Income tax value excess Excess profits tax profits tax 5-31-43 $ 27.00 $ 282.81 $ 19,870.02 5-31-44 70.41 681.75 18,828.56 *32 The sole question presented is whether the respondent erred in his determination that a public warehouse company, keeping its books and filing its returns on the accrual basis, could not during the first two years of its existence exclude from its income that portion thereof which the company set aside in a reserve account as its contractual liability to remove goods from its warehouse at the end of the storage period. FINDINGS OF FACT. The petitioner was organized on June 10, 1942, and the taxable years involved are the first two fiscal years of its existence. Petitioner, engaged in the public warehouse business in St. Paul, Minnesota, keeps its books and records and files its Federal income tax returns on the accrual basis, and uses a fiscal year ending May 31. Its returns for the taxable years were filed with the collector of internal revenue for the district of Minnesota. Petitioner's business is limited to the warehousing of dry merchandise, most of which is received in carload lots. It does not include the warehousing of household goods, cold storage products, or unsacked grain. At the time of the receipt of merchandise for storage, petitioner's customers, designated depositors, *33 were required to pay, in a single amount, a charge in accordance with the terms of various contracts. That portion of this charge made for receiving, stowing and redelivering stored merchandise was designated the "handling charge." It covered the cost of moving the goods into the warehouse from the freight cars, the cost of outbound movement or loading the goods from the warehouse back into cars, and such incidental charges as workmen's compensation, unemployment compensation, public liability insurance, and all pay roll charges attributable to touch labor. It also included cost of paper work and clerical work, depreciation on handling equipment, cost of power in elevation, and other items directly attributable to the movement of merchandise. The handling charge did not take into consideration any general overhead charge of the operation of the warehouse or any profits, such items being recorded in other accounts kept by the taxpayer. The handling charges were entered by the taxpayer in a separate ledger account known as "handling revenue," but the actual money realized therefrom was mingled with the taxpayer's general funds. *968 At some time during the fiscal year ended*34 May 31, 1943, petitioner set up on its books an account designated "Reserve for Handling Out." This is a liability account, the balance of which is eventually reflected on petitioner's balance sheet, and it was set up for the purpose of recording petitioner's liability for the redelivery of goods in storage. At the end of the fiscal year ended May 31, 1943, petitioner took an inventory of stored merchandise and adjusted its "Reserve for Handling Out" account. As a result of this adjustment the reserve was increased sufficiently so that 69 per cent of the revenue received by petitioner for handling charges during the year allocable to the stored merchandise included in said inventory was included in the reserve account. In selecting the figure of 69 per cent as the percentage of the handling revenue necessary to satisfy its liability for handling out merchandise in storage, petitioner was influenced by two factors. The first was its understanding that experience within the industry had shown that 60 per cent of the handling revenue was required to take care of the cost of handling out merchandise in storage, and the second represented its estimate that 9 per cent (15 per cent of*35 sixty) would be required to take care of an anticipated increase in labor costs. The allocation of 40 per cent of handling charges for handling in and 60 per cent for handling out was made by other warehouse concerns because merchandise came into their warehouses in carload lots and left in less than carload lots, thus requiring a greater expenditure for handling out than for handling in. However, the merchandise stored by petitioner, later developments disclose, was shipped out in carload lots. The transfers from petitioner's "Handling Revenue" account to its "Reserve for Handling Out" account were effected by debits to the first mentioned account, before any amount of its handling revenue was recorded as a credit in its profit and loss account, and by credits to the reserve account. The net amount removed from the "Handling Revenue" account and credited to the "Reserve for Handling Out" account during the fiscal year ended May 31, 1943, was $ 24,450.49. This procedure was again followed in the fiscal year ended May 31, 1944, when petitioner allocated an additional $ 2,994.42 to the "Reserve for Handling Out" account, and its books at the end of that year reflected a credit balance*36 in that account of $ 27,444.91. During the fiscal year ended May 31, 1945, $ 1,612.20 was removed from petitioner's "Reserve for Handling Out" account and transferred to its handling revenue account by a corresponding credit entry, and during the fiscal year ended May 31, 1946, a similar removal and transfer of $ 14,908.06 was made by petitioner. The removals were occasioned by the fact that there were more funds in the reserve account at the end of each of the two years last mentioned than were necessary to move out the goods that were in petitioner's warehouse at the end of those years. *969 In his notice of deficiency, the respondent determined that the $ 24,450.49 placed in the reserve in the taxable year ended May 31, 1943, and the $ 2,994.42 placed in the reserve in the taxable year ended May 31, 1944, did not represent deferred income for the respective taxable years and that said amounts should be included in gross income. OPINION. The sole issue for decision concerns the correctness of the respondent's determination that the petitioner may not exclude from its income for the taxable years the amounts transferred to its "Reserve for Handling Out" account. Section 41*37 of the Internal Revenue Code provides that net income shall be computed upon the basis of the taxpayer's annual accounting period 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 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. In Security Flour Mills Co. v. Commissioner, 321 U.S. 281, the Supreme Court said: The rationale of the system is this: "It is the essence of any system of taxation that it should produce revenue ascertainable, and payable to the government, at regular intervals. Only by such a system is it practicable to produce a regular flow of income and apply methods of accounting, assessment, and collection capable of practical operation." This legal principle has often been stated and applied. The uniform result has been denial both to government and to taxpayer of the privilege of allocating income or outgo to a year other than the year of actual receipt or payment, or, applying the accrual*38 basis, the year in which the right to receive, or the obligation to pay, has become final and definite in amount. The petitioner keeps its books on the accrual basis. It contends that it should be permitted to defer the inclusion of that part of its handling revenue transferred to its reserve for handling out in each of the taxable years because the amounts so transferred represented a definite and fixed liability to its depositors, or customers, to remove the goods from the warehouse in a subsequent year at no additional cost to such depositors. The only case cited in support of this contention is a memorandum decision of this Court wherein we held that a taxpayer on the accrual basis which, pursuant to a procedure long established and unquestioned, had deducted from gross income as an expense the actual calculated cost of labor to be performed, might continue to take such a deduction in the taxable year involved. Here we have no question of a deduction from gross income in conformity with a long established practice. Our question is whether a corporation during the first two *970 years of its existence may exclude from its income a substantial portion of its gross handling*39 revenue for each of those years. Cases in which taxpayers on the accrual basis have attempted to defer the reporting of income until a year subsequent to that in which the right to receive it became definite and certain are quite numerous and the facts of some of those cases, hereinafter mentioned, do not differ materially from those here involved. In Your Health Club, Inc., 4 T. C. 385, the taxpayer on the accrual basis received cash and accrued amounts within the taxable years under contracts obligating it to perform services extending beyond the taxable year. This Court held that the entire amount constituted income in the year when received or accrued, notwithstanding the fact that a part of the income was earned in the following year. In South Tacoma Motor Co., 3 T. C. 411, a taxpayer on the accrual basis attempted to defer certain amounts received from the sale of coupon books which entitled the purchaser thereof to services which might be called for and performed after the year of sale, and reported as gross income only that part of the proceeds allocable to the services it performed during the taxable year. The*40 taxpayer justified its deferment of income by contending that "the nature of the contract is such that petitioner will have to perform many of the services required by the contract subsequent to the taxable year in which the coupon book was sold." This Court held that the entire amount received from the sale of the coupon books was income for the taxable year in which received. In South Dade Farms, Inc., 138 Fed. (2d) 818, a taxpayer on the accrual basis collected $ 18,911.76 in cash as advance payments of rentals of farm lands for the next crop year. It credited this sum to an account styled "deposits for future rent," and when leases were signed in the succeeding fiscal year the sum was credited to "rental income." The taxpayer contended that its method of bookkeeping, in that it accounted for income in the fiscal year it was actually earned and deducted therefrom such expenses as were incurred in the earning thereof, reflected its actual net earnings more clearly than would any other method. The Circuit Court for the Fifth Circuit said: The difficulty of this position is that section 41, supra, required that the method of accounting should clearly*41 reflect income, not net earnings. In Brown v. Helvering [291 U.S. 193], where the taxpayer was on the accrual basis, it was held that money received without restriction upon its use and disposition by the recipient was income in the year received, even though it was received before it was earned and some portion of it might have to be refunded in the future. Since the advance rentals were income when received in the fiscal year ending in June, 1937, and since the taxpayer's bookkeeping method for reporting income did not take cognizance thereof, it is apparent that the method of accounting of the taxpayer did not clearly reflect its income. The Tax Court so held, and its decision is affirmed. *971 The Sixth Circuit Court of Appeals in Schram v. United States, 118 Fed. (2d) 541, discussed the prerogatives of the respondent under section 41 of the code in the following terms: * * * This is an administrative problem left by the statute to be determined "in the opinion of the Commissioner." Lucas v. Structural Steel Co., 281 U.S. 264, 50 S. Ct. 263, 74 L. Ed. 848.*42 That official has a broad administrative discretion in determining the question and it is beyond the power of the courts to overturn his decision unless the evidence clearly shows that he has abused his discretion. The taxpayer has failed to carry the burden of showing that the Commissioner acted arbitrarily upon any fair view of the facts. See Williamsport Wire Rope Co. v. United States, 277 U.S. 551, 562, 48 S. Ct. 587, 72 L. Ed. 985; Heiner v. Diamond Alkali Co., 288 U.S. 502, 507, 53 S. Ct. 413, 77 L. Ed. 921; Wells v. Moore, 6 Cir., 94 F. 2d. 108, 111. Upon the authority of these cases, we hold that the respondent correctly determined that the amounts of petitioner's handling revenue which it set aside in its "Reserve for Handling Out" account during the taxable years must be treated as part of its gross income for those years. Decision will be entered under Rule 50.