Rice, Barton & Fales, Inc. v. Commissioner

RICE, BARTON & FALES, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Rice, Barton & Fales, Inc. v. Commissioner Docket No. 14229. United States Board of Tax Appeals 15 B.T.A. 510; 1929 BTA LEXIS 2840; February 20, 1929, Promulgated *2840 1. The profit realized on a certain contract for the manufacture and sale of book-paper-making machines held to be taxable income in the year 1921. 2. Held, that the additional amount received on the sales price of a paper-making machine is taxable income in 1921, the year in which it was received. Harry Friedman, Esq., for the petitioner. Byron M. Coon, Esq., for the respondent. ARUNDELL *510 The respondent has determined a deficiency in income and excessprofits taxes for the year 1921 in the amount of $60,410.22, of which about $42,000 is in controversy. The questions in dispute are (1) whether the sum of $72,519.98, representing the profit made on the manufacture and sale of two paper-making machines, is income for the year 1921, and (2) whether the sum of $20,000 received by the petitioner in addition to the contract price for a drying machine is taxable income for the year 1921. FINDINGS OF FACT. The petitioner, a Massachusetts corporation, with principal offices in Worcester, prior to and in 1921 was engaged in the manufacture and sale of paper-making machines of its own design. On October 1, 1920, the petitioner*2841 entered into a written contract with Mitsui & Co., Ltd., a Japanese concern with an office in New York City, for the manufacture in accordance with specifications prepared by it, and for the sale at a price of $256,000, of two 86-inch, Fourdrinier book-paper-making machines. By the terms of the agreement, one-third of the sales price was payable before any shipments *511 were made and the balance was to be paid as part were shipped; all parts for the machines were to be delivered f.o.b. cars petitioner's works at Worcester, about May, 1921; the time of delivery was to be the date of shipment of parts for the machines from the petitioner's plant, and title was not to vest in the purchaser until the machines were fully paid for. Article IV of the contract reads as follows: The Builder guarantees the design, material and workmanship of the machinery specified, and further guarantees the correct mechanical operation of its several component parts. Any part or parts of this machinery, built by the Builder, shown to have been defective at the time of shipment, will be repaired or replaced, without charges F.O.B. cars Worcester, at any time within one year from date of shipment, *2842 provided the Purchaser gives immediate written notice upon discovery of such defect. No allowance will be made for repairs or alterations unless made with the written consent or approval of the Builder. The machines were designed for a minimum speed of 50 feet and a maximum speed of 350 feet of paper per minute. The final shipment of parts for the machines was made in September, 1921, and was received by the purchaser in Japan some time during the spring of the year 1922. The last payment on the contract purchase price of the machinery was made at the time of the final shipment of parts. Because of their great size, and other conditions, it was impracticable for the petitioner to assemble the machines at its plant before delivery to determine definitely whether they would operate satisfactorily. Certain units or parts of units of the machines were, however, assembled for testing purposes prior to their shipment. The purchaser did not inspect the parts for the machines during their manufacture, and the machines were not completely assembled until after the final shipment of parts reached the purchaser's plant in Japan in 1922. During the 90 or more years the petitioner*2843 has been in the business of making paper machines it has never built two machines exactly alike. It is impossible for the petitioner to determine in advance of the operation of a paper-making machine whether it will work satisfactorily. The petitioner, however, because of its experience and the ability of its engineers, is able to design and manufacture a paper-making machine with reasonable assurance that it will perform satisfactorily when assembled. During the years 1920, 1921, and 1922 petitioner's practice was to enter on its books the profit or loss on contracts in the year in which machines were accepted by the purchasers. The profit of $72,519.98 realized by the petitioner on the aforementioned contract was entered on its books and returned as income in the year 1922. On an audit *512 of its returns, the respondent transferred the sum from the year 1922 to the year 1921. On December 22, 1916, the petitioner contracted in writing with the Riordan Pulp & Paper Co., Ltd., (now Kipawa Fibre Co.) for the manufacture and delivery not later than November 1, 1917, of a sulphite dryer machine for the sum of $109,530. At the request of the purchaser, the petitioner*2844 delayed the delivery of the machine indefinitely. The final shipment of parts for the machine was made in about September, 1919. The machine was put in operation and accepted by the purchaser in 1920. Prior to the delivery of the last set of parts for the machine, the petitioner ascertained that due to conditions resulting from the delay in making delivery, the cost of manufacturing the machine had been in excess of the original estimated amount, and that it had sustained a loss under the contract instead of an anticipated profit. The parties have stipulated that the loss sustained was $20,000. In accordance with petitioner's accounting method, this loss was entered on its books in 1920. On September 10, 1919, the petitioner advised the purchaser by letter that due to the delay in making delivery of the machine at the latter's request, the cost of manufacturing the machine had been a great deal more than it would have cost it had the machine been delivered at the time originally agreed upon and requested a conference to discuss the question of additional compensation to reimburse it for the added manufacturing costs caused by the delay in shipment. On October 18, 1920, the*2845 Paper Company informed the petitioner by letter that it had decided "to make a further payment of $20,000 on the Drying Machine you built for us at Kipawa." The check not having been received by December 10, 1920, the petitioner, on that date, inquired of the purchaser in writing "as to when we may expect to receive this payment." The petitioner in a letter dated December 17, acknowledging receipt of the purchaser's reply to its letter of December 10, said that "we appreciate sincerely your assurance that we will receive your check for the further payment of $20,000 on account of the drying machine, before the end of the year." The Paper Company's check for $20,000 was taken into account on January 3, 1921, by debiting cash and crediting surplus for the amount thereof with the following notation "Payment received from Kipawa without legal obligation." On the same date the petitioner acknowledged receipt of the remittance as "being additional compensation on the drying machine which we furnished you some time ago." The loss of $20,000 sustained under the contract was deducted from gross income in the year 1920. In its return for the year 1921, the petitioner reported the sum of*2846 $20,000 received from the Paper Company *513 as a "gift received without legal obligation." The respondent determined that the sum was taxable income under the theory that the amount represented an additional payment under the contract. OPINION. ARUNDELL: The petitioner contends that the respondent erred in including in 1921 income the gain realized from the Mitsui contract because the regular practice of petitioner was to take up income in the year in which the goods manufactured under contract are accepted by the purchaser, which in this case it is claimed was in the year 1922. This practice it is argued is in accordance with that part of section 212(b) of the 1921 Act which provides that income shall be computed in accordance with the method regularly employed in keeping the books and subdivision (b) of article 36, Regulations 62, which deals with long-term contracts. The contract here involved was executed October 1, 1920, and was to be completed by delivery of all parts f.o.b. Worcester "about May, 1921." As a matter of fact completion was delayed until September of 1921. Petitioner's argument on this point is that the contract was not completed within the meaning*2847 of article 36, Regulations 62, until the machines were set up in 1922 and operated, and cites section 47 of the Uniform Sales Act and several court decisions dealing with the question of right of inspection before acceptance. The citations are not in point. The contract we have here specifically provides that "the time of delivery is understood to be the date of shipment from the works of the builder." The contract reserved title in the builder until the machinery was fully paid for, which occurred in September, 1921. The contract was purposely so drawn in order to avoid difficulties that might have been encountered in enforcing payment after the machines reached Japan. The only conclusion that we can arrive at from these provisions is that upon the final loading of parts and payment therefor the sale was completed and the income from the transaction realized. True, there was petitioner's guarantee that any parts built by it shown to have been defective at the time of shipment would be replaced free of charge, but this, as said with respect to a maintenance clause in contracts involved in *2848 , was collateral to the main contract. See also . This is not contrary to , relied upon by petitioner. That case dealt with the right of a vendee to rescind the contract and sue for recovery of the purchase price. That right may or may not exist under the present contract, but we have no occasion in this proceeding to declare either way. All that we are concerned with is to determine whether *514 the gain realized from the contract is income in the year 1921. Petitioner had complied with its share of the bargain when it manufactured the machinery and delivered it to the vendee at the place specified. The vendee had discharged its obligations by acceptance at the place of delivery and payment of the contract price. Nothing remained to be done. The possibility of subsequent adjustments under the guarantee places the petitioner in no different situation than were the taxpayers in *2849 ; ; ; and As to petitioner's method of keeping its books, the evidence is that they were kept according to the "finished contract method," that is, that profit or loss was not entered on the books until the machinery contracted for was put into operation and accepted, and that this method was used during the years 1920, 1921, and 1922. The terms of other contracts under which the petitioner manufactured goods for domestic purchasers are not in evidence, but it appears from the testimony that in such cases petitioner had but little fear of being unable to secure payment from the purchasers. The Mitsui contract, however, was entirely different. There petitioner entertained some doubt as to its ability to enforce collection in a foreign country and it accordingly protected itself by specifically providing in the contract for delivery within the United States and payment at that time. While for conservative accounting purposes it may have been proper to defer accounting*2850 for income under this contract until the machines were set up in Japan, such postponement is not proper under Federal taxing statutes. It is said in , that: For its own purposes the plaintiff had the right to keep its books in such a manner that it could determine whether it had gained or lost upon each of its contracts. From that viewpoint its original method of bookkeeping may be quite correct, as, indeed, may be the method used in the amended return; but when, for tax purposes, gross income is carried as a liability for five years, with the result that the company is made to appear to have lost money during a particular year in which it actually made a considerable gain, then the method does not clearly reflect taxable income. We have the same situation here except in the time of withholding income, which is a matter of degree only. In our opinion the gain realized from the Mitsui contract should have been reported in the year 1921 in order to correctly reflect income for that year. There are several arguments made against the inclusion in income by the respondent of the $20,000 received from the Riordan*2851 Company. One is that the amount was a gift. This theory does not impress us. It was claimed, as shown by the correspondence, as the amount of additional cost to build the machine which was caused by the delay *515 in construction at the purchaser's request. It was, as said by the purchaser in its letter, a further payment on the drying machine. Regardless of whether the claim was enforceable or not, the payment was clearly one growing out of a business transaction and was not merely a gratuity. See . It is further urged that the $20,000 is only a diminution of a loss and therefore can not be income. It is agreed by the parties that the cost to petitioner of manufacturing the machine was $20,000 more than the contract price. But petitioner had the benefit of this loss as a deduction against income in 1920 and consequently when the payment was received later it was income, Cf. . The argument proceeds that if the amount is income in any year it is income in 1920 because the check was received in that year and the petitioner was on the accrual and completed-contract*2852 basis. The evidence is not at all clear as to when the check was received. All that we have on this is that receipt of the check was acknowledged on January 3, 1921, and entered on the books on that date. This is not sufficient to overcome the presumption of correctness attaching to the respondent's finding. In view of petitioner's insistence that there was no enforceable obligation in respect to this payment, it hardly seems that it had anything to accrue prior to actual receipt. Judgment will be entered for the respondent.