La Salle Cement Co. v. Commissioner

LASALLE CEMENT CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ALPHA PORTLAND CEMENT CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. La Salle Cement Co. v. Commissioner Docket Nos. 22453, 24708. United States Board of Tax Appeals 15 B.T.A. 1127; 1929 BTA LEXIS 2723; March 27, 1929, Promulgated *2723 1. Petitioners sold their product in cotton bags, reserving the property in such bags. Purchasers were charged a fixed amount for each bag, which was repaid to them upon the return of the bags. The amount so charged and returned exceeded the cost of the bags. Upon the books of the petitioner the difference between the amount charged and the cost was set up in a "Bag Redemption" account. As bags were returned contraentries were made in that account. Experience indicated that 10.1 per cent of bags shipped would not be returned. The Commissioner included as income the increase during the year in the balance of the "Bag Redemption" account. Held, that in the circumstances shown, such treatment of the account distorted income and was erroneous. 2. Held, further, that income represented by such transactions is properly reflected by including as income 10.1 per cent of the amounts credited to "Bag Redemption" account during the year. F. C. Taylor, Esq., for the petitioner. E. C. Lake, Esq., for the respondent. PHILLIPS *1127 The Commissioner determined deficiencies of $143,413.16 and $31,325.92 in income and profits taxes of the*2724 LaSalle Cement Co. for the fiscal year ended May 31, 1920, and for the fiscal period ended November 30, 1920, respectively. He notified the LaSalle Cement Co. of his determination, which thereupon instituted the proceeding known as Docket No. 22453 for a redetermination thereof. From January 1, 1920, to November 30, 1920, the LaSalle Cement Co. was affilated with Ironton Portland Cement Co. The assets *1128 of both these companies having been purchased by Alpha Portland Cement Co., which had assumed all of the liabilities of these companies, the Commissioner asserted a liability against the latter company, under section 280 of the Revenue Act of 1926, as a transferee of the LaSalle and Ironton companies. The Alpha Portland Cement Co. instituted the proceeding known as Docket No. 34708 for a redetermination of its liability. The two proceedings were consolidated. Several issues were set out in each petition, all but one of which have been disposed of by a stipulation filed with the Board reading as follows: 1. That the Alpha Portland Cement Company is the real party in interest herein and that upon final determination of the deficiency, the Board of Tax Appeals may*2725 enter an order of redetermination for the full amount thereof, if any, against and in the name of the said Alpha Portland Cement Company. 2. That the parties are in agreement as to all of the issues involved in these appeals except the treatment of the cement sack account. 3. That, if no adjustments to the said sack account other than those already made by the respondent in his deficiency letters, become necessary as a result of the Board's decision, to be rendered herein, that the net taxable income for the fiscal year ended May 31, 1920, may be found by the Board to be $760,424.10, and for the period November 30, 1920, $784,014.44. But if adjustments to the said sack account result by reason of the decision of the Board to be rendered on this issue, then the amount of the net taxable income for the respective periods shall be modified to the extent of any such adjustments. FINDINGS OF FACT. During the periods here involved the LaSalle Cement Co. (hereinafter referred to as LaSalle) was a corporation organized and existing under the laws of the State of Illinois and owned and operated a cement mill at LaSalle, Ill. On January 1, 1920, LaSalle purchased all the issued*2726 capital stock of the Ironton Portland Cement Co. (hereinafter referred to as Ironton), a corporation organized and existing under the laws of the State of Ohio, which owned and operated a cement mill at Ironton, Ohio. During the period from January 1, 1920, to November 30, 1920, LaSalle and Ironton were affiliated within the meaning of section 240(b) of the Revenue Act of 1918. A consolidated return of the income of LaSalle for its fiscal year ended May 31, 1920, and of the income of Ironton from January 1, 1920, to May 31, 1920, was filed with the United States collector of internal revenue of northern Illinois. A consolidated return of the income of LaSalle and Ironton for the period from January 1, 1920, to November 30, 1920, was filed with said collector. Upon audit of said consolidated returns the Commissioner determined the deficiencies here in question. On November 30, 1920, the Alpha Portland Cement Co. (hereinafter referred to as Alpha) a corporation organized and existing *1129 under the laws of the State of New Jersey, acquired all of the property and assets of LaSalle and of Ironton and assumed their obligations. Thereafter LaSalle and Ironton were dissolved. *2727 Both LaSalle and Ironton sold during the period in question large quantities of cement packed in cotton bags. The bags in which said cement was shipped were suitable for reuse and repacking and were conspicuously marked with the respective company's name and trademark. Both companies sold cement under a standard form of contract which contained special provisions in regard to the bag in which the cement was shipped. The provisions of the contracts of both companies with respect to such bags were substantially the same except for the name of the brand, the amount of the charge, and the location of the plant to which sacks were to be returned, and read as follows: Cloth sacks bearing brand, in which cement herein contracted for is packed, are the property of Cement Company and are for a period of ninety (90) days from the delivery by Cement Company of the said cement leased by it to purchaser at a charge of cents each, which charge is included in price for cement packed in cloth sacks and which charge Purchaser agrees to pay at the same time and on same terms as payment for cement is made. Purchaser agrees within ninety (90) days of delivery of the cement to deliver to Cement*2728 Company, the owner, at its plant at , freight prepaid, properly bundled and so marked as to insure complete identification, the sacks bearing brand in which said cement is packed, and Cement Company agrees to refund to Purchaser cents for each said sack so delivered in good condition subject to its count and inspection. For useless sacks or sacks which have been wet, no refund will be made. Foreign sacks will be held by Cement Company for thirty (30) days subject to Purchaser's order. In the event that any of the said empty sacks bearing brand are sold or otherwise disposed of to any person other than Cement Company, the owner, Purchaser agrees to pay Cement Company, as liquidated damages, cents for each sack so sold or disposed of. The amount to be refunded upon the return of each sack was the same amount which was charged for such sack. The bags were identified by marks in order that an inspection would show at what refund charge they had been shipped. LaSalle and Ironton had special facilities for repairing and cleaning bags, which they maintained at considerable expense. Their customers maintained no such facilities. In recording upon their books the charge for the*2729 bag, the withdrawal of the bag from inventory, and the obligation to refund, both LaSalle and Ironton made the following entries at the time of shipment: (1) Charged the customer with the amount of the bag refund as specified in the contract, (2) Credited bag inventory account with the amount at which such bags were included in inventory, and *1130 (3) Credited "Bag Redemption" account with the difference between the amount charged for the bags (which was the same amount which was to be refunded on their return) and the inventory value of the bags. The amount charged to the customer equaled the sum of the amounts credited to the bag inventory account and the bag redemption account. The amount charged to the customer for the bags and to be refunded upon their return exceeded the inventory values of the bags. During the fiscal year ended May 31, 1920, LaSalle shipped to customers 4,056,917 bags and redeemed 3,209,272 bags. In the period from June 1, 1920, to November 30, 1920, LaSalle shipped to customers 2,401,157 bags and redeemed 2,510,379 bags. For the period from January 1, 1920, to May 31, 1920, Ironton shipped to customers 555,000 bags and redeemed 323,449*2730 bags. For the period from June 1, 1920, to November 30, 1920, Ironton shipped to customers 1,154,328 bags and redeemed 881,534 bags. A similar practice of redeeming bags is customary in the industry. The experience of petitioners over the period from April, 1913, to December, 1918, was that 89.9 per cent of such bags would be returned for redemption. The average time for the return of such bags is about 90 days. The books of LaSalle on June 1, 1919, showed a "Bag Redemption" account of $60,426.88, and on May 31, 1920, showed this account to be $166,553.39, or an increase in said account of $106,126.51 during that period. The books of LaSalle on November 30, 1920, showed a "Bag Redemption" account of $155,547.10, or a decrease of $11,006.29 during the period from June 1, 1920. Ironton first opened its "Bag Redemption" account on January 1, 1920, and the books of said Ironton show that on May 31, 1920, the amount of said account was $32,065.64 and that on November 30, 1920, the amount of said account was $47,598.76. The Commissioner has included as taxable income for the respective periods the difference between the amount of these accounts at the beginning and at the end*2731 of each period, as follows: Increase Decrease Period ending May 31, 1920: LaSalle $106,126.51 Ironton 32,065.64 Increase in consolidated income 138,192.15 Period June 1, 1920, to November 30, 1920: LaSalle $11,006.29 Ironton $15,533.12 Increase in consolidated income 4,526.82 The accounts of LaSalle and Ironton were kept on an accrual basis during the periods in question. *1131 OPINION. PHILLIPS: The stipulation filed by the parties disposes of all issues except that the proper treatment, in computing net income, of the transactions in cloth bags which are detailed in the findings. In , a deduction from income was claimed by reason of somewhat similar transactions and was denied by the Board. The present case is presented upon a different state of facts and a different theory and this prior decision is not, as counsel for the respondent contends, decisive of the question before us. From the facts in that case it appeared that the petitioner there sold its bags with an agreement to repurchase at the sales price when returned. The sales price, although arbitrarily fixed, *2732 was substantially the same as cost. The question presented by that state of facts was whether any deduction could be taken by reason of the obligation to repurchase the bags. Here the evidence is that the petitioner did not sell its bags. The form of the transaction was a lease, petitioner retaining title, with provisions for liquidated damage in the event that the bags were not returned. The amount charged to the customer until the bags were returned exceeded the cost of the bags. The question now presented is not one of allowing a deduction from income; rather, it is whether these transactions gave rise to any income and, if so, how much. Upon the record before us, it seems clear that these bags were not sold by petitioner to its customers at the time they were shipped out. It seems equally clear, however, that some income was derived from these transactions. The deposit exacted from the customer exceeded the cost of the bags to petitioner. To the extent that such deposits were forfeited, the excess over cost of bags represents income. If the number shipped out was the same from month to month and the bags were returned in a constant, even manner, an equal number being*2733 returned each month, the difference between the balance in the "Bag Redemption" account at the beginning of any period and at the end of that period would correctly reflect the excess of the forfeited deposits over cost. But the record discloses that such is not the case. The amounts shipped varied from time to time, as did the promptness with which bags were returned. The result has been that the Commissioner, using the difference between the balances in the account at various dates, has determined a profit of $138,162.15 for a year in which 4,611,917 bags were shipped and a profit of $4,526.83 for a period during which 3,555,485 bags were shipped. Even worse, he has determined a loss to one of the companies during one of these periods when it must be evident that these transactions can not result in a loss, for petitioner receives more for its forfeited *1132 bags that they cost and for bags returned it returns only what has been deposited with it. The result is bound to be a profit. We conclude that the method used by respondent, while it may be correct in principle when properly applied, does not correctly reflect the income of the petitioners for the years before*2734 us. On the contrary, it seriously distorts the true income. The situation is not unlike that which was presented in , where one of the questions presented was whether the petitioner should accrue as income interest on certain bonds when it appeared that such interest could not be paid. The Board said (p. 269): If the petitioner had kept its acounts in the manner suggested by the respondent it would have reported to the public each year that it had earned income in excess of one million and a half dollars which, as a matter of fact, it had not received and which in all probability it would never receive. Such a system of accounting would not have reflected the petitioner's true income but would have given to its stockholders and the public a false idea of its income. Had the present taxpayers in their financial statements considered the charges for bag deposits outstanding May 31, 1920, as income received during the preceding year, they "would have given to their stockholders and the public a false idea of their income." On the other hand, we can not agree with petitioners that no part of the amounts collected from*2735 customers as security for the return of the sacks is income. There is a gain to petitioners for every sack which is not returned. Experience showed that 10.1 per cent of the sacks sent out would never be returned. On this basis, the unclaimed amount is bound to increase from year to year. As we have pointed out above, if this increase was distributed evenly or ratably over the years, the amount of the income would be reflected by the increase in the "Bag Redemption" account, but this is not the situation. It was urged by the petitioner at the hearing that if any part of the unreturned deposit carried in this account was income, it would be only 10.1 per cent of the net increase in the account during the year. At the hearing it was pointed out that 10.1 per cent was the ratio which unreturned bags bore to the total number of bags shipped during the year and that if such ratio was to be used it would have to be applied to the shipments of bags for the entire year and not merely to those unreturned at the close of the year. In other words, the experience was that 10.1 per cent of all bags shipped would not be returned and this can not be applied only to the number unreturned at*2736 the end of the year to arrive at the number of defaults which took place during the year. Counsel for petitioners in their brief recognize the force of this method of computing the amount which was forfeited. *1133 The amounts credited to the "Bag Redemption" account during the year represent the difference between the amounts deposited and the cost of the bags. If none of the bags shipped during the year were returned, the amounts credited to the account during the year would all become income. But experience indicates that 89.9 per cent will be returned and 10.1 per cent will be forfeited. We are consequently of the opinion that the income of petitioners will be reflected by including as income for each of the taxable periods 10.1 per cent of the amounts so credited to this account during the year. The net income as set out in the stipulation should be adjusted accordingly. Reviewed by the Board. Decision will be entered under Rule 50. ARUNDELL dissents. STERNHAGEN STERNHAGEN, dissenting: It seems to me that the amount received or accrued in a year for the bags is among the company's gross receipts and this is reduced by the amount paid out*2737 or definitely incurred by way of "refund." The apparent distortions of one year are equalized in the next if the accounting is uniform and consistent. There is no legal justification for measuring income upon an estimate of the percentage of bags likely to be returned or the probable amount likely to be refunded, even if the estimate be based on testimony of actual past experience. TRAMMELL, VAN FOSSAN, and MURDOCK agree with this dissent.