Arcade Dep't Store, Inc. v. Commissioner

ARCADE DEPARTMENT STORE, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Arcade Dep't Store, Inc. v. Commissioner Docket No. 6298. United States Board of Tax Appeals 18 B.T.A. 1172; 1930 BTA LEXIS 2514; February 14, 1930, Promulgated *2514 1. Inventory adjustment made by the respondent approved. 2. Basis for depreciation deductions for taxable period and year redetermined. 3. Evidence insufficient to determine that the respondent erred as to certain deductions claimed on account of bad debts and salaries of officers. 4. Under the laws of Washington state personal property taxes are due in the first year subsequent to the levy thereof. Held, such taxes in this controversy were deductible from petitioner's income in the years levied, though not paid until the following years. 5. In the circumstances herein the statute of limitations does not apply to the deficiency asserted for the year 1918. Wells Bros. Co. of Illinois et al.,16 B.T.A. 79. Harold B. Gilbert, Esq., for the petitioner. Arthur H. Murray, Esq., for the respondent. LANSDON *1172 The respondent has asserted deficiencies in income and profits taxes for the period July 1, 1918, to December 31, 1918, and for the year 1919, in the respective amounts of $3,847.82 and $1,117.77. For its causes of action the petitioner alleges: (1) That its opening inventory at date of incorporation*2515 was undervalued in the amount of $10,500, and that respondent is in error in refusing to allow any adjustment of such inventory value for income and excess profits purposes; (2) That the respondent has erroneously disallowed as deductions from its gross income for the taxable period and year involved reasonable amounts on account of depreciation of capital assets; (3) The erroneous disallowance of $780.15 as a deduction from gross income for 1919 on account of debts alleged to have been worthless and to have been charged off in that year; (4) That the respondent erroneously allocated to the taxable period ended December 31, 1918, certain salary payments that were an expense to its business in 1919; (5) That state personal property taxes for the years 1918 and 1919, paid in the years 1919 and 1920, are proper accruals on its books for the year in which such taxes were levied; and (6) That the statute of limitations had run against a collection of the deficiencies asserted when the respondent's deficiency letter was issued. *1173 FINDINGS OF FACT. The petitioner, in the taxable period and year involved, was a Washington corporation, with its principal place of*2516 business in Toppenish, where it conducted a department store. It was organized August 17, 1918, as the successor of Hinman & Dobrin, a partnership, theretofore engaged in the dry goods and ladies' furnishing business, and E. J. Tweed, who was engaged in the grocery business as an individual. The capital stock at date of organization was $50,000. Upon its incorporation, the petitioner took over merchandise stocks, store fixtures and receivables, and assumed the payables of the two predecessor concerns. No inventories of merchandise stocks and fixtures acquired at date of incorporation were made at that time. In arriving at the value of merchandise acquired for stock, the inventories of the predecessor concerns as of January 1, 1918, were used as a basis, additions and sales during the time intervening before August 17 were considered, and estimated values of the merchandise taken into the assets of the petitioner were made in the respective amounts of $69,325.96 and $4,500. The fixtures, receivables, and payables of the predecessors were transferred to the accounts of the petitioner at book value at date of the incorporation. Some time before the close of the first taxable*2517 period here involved, the prior owners of the merchandise stocks acquired from the partnership and the individual business decided that such stocks had been taken into the accounts of the petitioner at figures substantially below actual value at August 17, 1918. To correct this alleged undervaluation, the accounts of the members of the partnership, and of the individual, were credited with the respective amounts of $10,000 and $500; but no additional stock was issued, nor were any cash payments ever made on account of such entries. At December 31, 1918, the petitioner made a closing inventory, on some basis not clearly disclosed by the record, which showed merchandise on hand at that date of the value of $74,512.40. In its income and profits-tax return for such period it reported a closing inventory of $64,012.40. This write-down represents the alleged undervaluation of merchandise acquired at date of incorporation and subsequently credited to the prior owners thereof, and reduced the gross profits of the business for the period as shown by the books in the same amount. Upon audit of such return the respondent restored this inventory write-off and correspondingly increased the*2518 gross profits of the business. At date of incorporation the petitioner took into its asset accounts furniture and fixtures acquired from prior owners at a book value of $6,814.28. Such assets consisted of a mixed body of fitments and *1174 equipment made up of counters, shelving, scales, and other furniture and fixtures commonly used in the dry goods and grocery business. There is nothing in the record that discloses the original cost, the accrued depreciation, or the remaining useful life of such property at date of its acquisition by the petitioner. Subsequent to August 17, 1918, and prior to January 1, 1919, the petitioner acquired a Burroughs posting machine and a Lamson cash carrier, at respective costs of $500 and $2,400. The useful life of such equipment is 10 years. During the same period it acquired a desk, a typewriter, a showcase, and a new clothing cabinet at respective costs of $85, $60, $50, and $182.50. The useful life of these articles at date of acquisition was six years. In the same period it acquired a new Dodge delivery truck at a cost of $1,250. The useful life of such truck, when purchased, was four years. In its income and profits-tax return*2519 for the period and years here involved the petitioner deducted from its gross income the respective amounts of $445.47 and $1,484.55 on account of depreciation of physical assets used in its business. Upon audit, the Commissioner disallowed such deductions. At December 31, 1919, the petitioner charged off $2,584.03, alleged to represent bad debts or losses sustained during the taxable year, and in its income and profits-tax return deducted such amount from its gross income for such year. Upon audit the respondent disallowed $780.15 of this amount. Upon audit of the petitioner's income and profits-tax returns for the period ended December 31, 1918, and the year 1919, the respondent reduced the deduction from gross income on account of salaries for the year 1919, in the amount of $3,000, and allowed the amount so deducted as deduction from gross income for the period ended December 31, 1918, on account of salaries for that period. In the years 1919 and 1920 the petitioner paid state and local personal property taxes for the years 1918 and 1919 in the respective amounts of $360.72 and $1,295.60, accrued such payments on its books for the period ended December 31, 1918, and*2520 the year 1919, in its income and profits-tax returns, and deducted the amounts so paid from its gross income for the respective period and year. The petitioner filed its income and excess-profits-tax returns for the taxable period ended December 31, 1918, and for the year 1919 on May 1, 1919, and March 13, 1920, respectively. On April 11, 1924, consent was entered into in writing by the officers of the petitioner and the respondent which extended the period of time within which the Commissioner of Internal Revenue might determine, assess and collect any tax from petitioner for the year 1918 until one year after the expiration of the statutory period of limitation then running against the same, or until May 1, 1925. *1175 On or about June 17, 1925, the respondent mailed the deficiency notice which is the basis of this proceeding. On August 15, 1925, the petitioner filed a petition with this Board asking that the deficiency so asserted be redetermined. On September 8, 1925, the respondent filed his answer to such petition. On December 1, 1925, the following waiver was executed in writing between officers of the petitioner and the respondent: In pursuance of the provisions*2521 of existing Internal Revenue Laws Arcade Department Store, Inc., a taxpayer of Yakima, Washington, and the Commissioner of Internal Revenue hereby waive the time prescribed by law for making any assessment of the amount of income, excess-profits, or war-profits taxes due under any return made by or on behalf of said taxpayer for the years 1918 and 1919, under existing revenue acts, or under prior revenue acts. This waiver of the time for making any assessment as aforesaid shall remain in effect until December 31, 1926, and shall then expire except that if a notice of a deficiency in tax is sent to said taxpayer by registered mail before said date and (1) no appeal is filed therefrom with the United States Board of Tax Appeals then said date shall be extended sixty days, or (2) if an appeal is filed with said Board then said date shall be extended by the number of days between the date of mailing of said notice of deficiency and the date of final decision by said Board. The Revenue Act of 1924, including section 278(e), became effective on June 2, 1924. No assessment of the deficiencies in controversy was made prior to June 2, 1924, but such deficiencies were assessed*2522 on September 26, 1926, after the enactment of the Revenue Act of 1926. OPINION. LANSDON: The issues involved in this proceeding are fully set forth in our preliminary statement and need not be repeated here. They will be discussed and decided in the order there stated. When the petitioner began business on August 17, 1918, it took into its asset accounts the estimated value of certain merchandise which it acquired from predecessor concerns in exchange for its stock. At that date all the parties in interest were in agreement as to such value. At some undisclosed date, but prior to December 31, 1918, certain of the prior owners became dissatisfied with the values determined at organization. After some discussion all agreed that the partnership assets and the assets of the individual business were worth, respectively, $10,000 and $500 more than the agreed value at August 17, 1918, and the parties in interest were severally credited on the books of the petitioner with their respective proportionate parts of such alleged additional value. In making its income and profits-tax return for the period in question in the determination of its gross income, the petitioner reduced*2523 its closing inventory in the amount it had so credited to prior owners, or $10,500. *1176 It is obvious that the procedure adopted was erroneous. If the assets acquired at August 17, 1918, had the value now alleged, the adjustment should have been made by an addition to the opening inventory of the amount so claimed, and the resulting increase would then have been reflected in increased invested capital and decreased income for the taxable period. The method used disturbed invested capital for the taxable period, and if carried into the opening inventory for 1919, distorted income for that year. It seems, however, that for its opening inventory for 1919, the petitioner carried forward its true closing inventory from the preceding period, and in its income and profits-tax return for such year decreased its closing inventory by $10,500. This erroneous accounting resulted in numerous adjustment problems, all of which are capable of solution if the basis of the changes was correct. The whole matter, therefore, resolves itself into an inquiry as to whether the merchandise which the petitioner acquired for stock at August 17, 1918, had a value of $10,500 in excess of the amounts*2524 entered on the books. At the hearing the petitioner accepted the burden of proof and undertook to show that its opening inventory at August 17, 1918, was understated by the amount of $10,500. The evidence in support of this contention is not persuasive. It is conceded that no physical inventory was made. The amounts entered on the books resulted from an estimate in which all the parties in interest participated and in the result of which all agreed. The verbal agreement as to greater value, subsequently made, also was based on an estimate and is not supported by an actual physical inventory made on cost or cost or market. Upon the record, we are unable to find that the values agreed to at the date of incorporation were erroneous. On this issue the evidence is not sufficient to overcome the presumption that the determination of the respondent is correct. . At date of incorporation the petitioner acquired depreciable assets from prior owners which it entered on its books at a value of $6,814.28. The record does not satisfactorily establish the remaining useful life of the various articles then and so acquired and, consequently, *2525 there is no basis upon which we can compute depreciation thereon for the taxable period and year here involved. On the property acquired between August 17, 1918, and January 1, 1919, the petitioner is entitled to deduct depreciation for the year 1919 on the basis of the cost and useful life of the various items as set forth in our findings of fact. The evidence in support of the petitioner's contention that it is entitled to deduction of $3,000 on account of additional salaries for 1919 is not sufficient to enable us to hold that the respondent erroneously allocated such salary to the taxable period ended December *1177 31, 1918. A similar infirmity in the evidence constrains us to approve the determination of the respondent as to the deduction for bad debts for the year 1919. On March 18, 1919, the petitioner paid the personal-property tax of the partnership for the year 1918 in the amount of $360.72, and on March 16, 1920, it paid its personal-property tax for the year 1919 in the amount of $1,295.60. It is not disputed that these payments were made on account of taxes for the respective years indicated or that such payments were due sometime in March subsequent to*2526 the respective years for which they were levied. It is the contention of the petitioner that the taxes paid in 1919 and 1920 were properly accruable on its books for the years 1918 and 1919, and its income and profits-tax returns having been made on the accrual basis, are proper deductions from its gross income for the respective years in which they were levied. The laws of the State of Washington provide as to personal-property taxes (1) that the assessment of values shall be made not later than February 1 of each year; (2) that levies of tax on such property shall be made in October of the same year; (3) that the tax rolls shall be delivered to the county treasurer in the next succeeding January; and (4) that, "On and after the first Monday of February succeeding the levying of taxes the county treasurer shall proceed to collect all personal property taxes." Remington's Code and Statutes of the State of Washington, sections 9102, 9213, 9218, and 9223. In the light of our prior decisions the due and payable dates do not determine when such taxes become accruable obligations of the taxpayer. These taxes were levied on October of 1918 and 1919, respectively, and at such dates*2527 became obligations of the taxpayer which it was entitled then to accrue on its books as liabilities. The contention of the petitioner on this issue is sustained. ; . The petitioner, in its brief, has abandoned its contention that the statute of limitations had run against the determination, assessment and collection of the deficiency for 1919 at the date when the deficiency notice pertaining thereto was mailed. It still maintains, however, that the determination, assessment and collection of the deficiency for 1918 is barred by such statute. None of the facts relating to the filing of the return or the execution of the consents is in dispute. The petitioner's income and excess-profits-tax return for the period ended December 31, 1918, was filed on May 1, 1919. It is obvious that in the absence of waivers the five-year period of limitations then effective would have run against any additional tax liability determined therefrom at May 1, 1924. On April 11, 1924, a consent was executed which had the effect of extending the statutory *1178 period for one year, *2528 or until May 1, 1925, at which date the determination, assessment and collection of any additional tax liability was barred, unless the Revenue Act of 1924 or the waiver executed on December 1, 1925, one or the other, or both, operated to further stay the statute. The issue is governed by the following sections of the Revenue Act of 1918, under which the taxes accrued, and the Revenue Act of 1924, under which the assessment was made. Revenue Act of 1918: SEC. 250. (d) Except in the case of false or fraudulent returns with intent to evade the tax, the amount of tax due under any return shall be determined and assessed by the Commissioner within five years after the return was due or was made, and no suit or proceeding for the collection of any tax shall be begun after the expiration of five years after the date when the return was due or was made. In the case of such false or fraudulent returns, the amount of tax due may be determined at any time after the return is filed, and the tax may be collected at any time after it becomes due. Revenue Act of 1924: SEC. 277. (a) (2) The amount of income, excess-profits, and war-profits taxes imposed by * * * the Revenue Act of 1918, *2529 * * * shall be assessed within five years after the return was filed, and no proceeding in court for the collection of such taxes shall be begun after the expiration of such period. * * * SEC. 278. (c) Where both the Commissioner and the taxpayer have consented in writing to the assessment of the tax after the time prescribed in section 277 for its assessment the tax may be assessed at any time prior to the expiration of the period agreed upon. In the instant proceeding the consent executed on April 11, 1924, extended the time within which determination, assessment and collection might be made until May 1, 1925. The Commissioner failed to move in the matter in any way within the five-year period of limitation or the extension thereof as consented to by the parties. It follows, therefore, under the plain terms of the Revenue Acts of 1918 and 1924, that after May 1, 1925, the respondent was without authority to determine, assess or collect any additional tax liability on account of the petitioner's return for the period ended December 31, 1918, unless the waiver executed on December 1, 1925, reinstated in him the authority which had lapsed at May 1 of that year. Cf. *2530 , and . The right, if any, of the Commissioner to move after the expiration of the statutory period of limitation is based on section 278(c) of the Act of 1924, supra. The respondent contends that the writing entered into on December 1, 1925, satisfied the terms of that provision, restored his authority to assess, and enlarged the time for the exercise thereof for one year, or more than one year if the petitioner should appeal to the Board. *1179 We are of the opinion that, on the facts, the case at bar is within the rule of . We hold, therefore, that the Commissioner under and by virtue of the provisions of section 278(c), supra, and the waiver of December 1, 1925, had authority to determine and assess the tax complained of, at the time of such determination and assessment, and that his acts in respect thereto must be approved. Cf. Stange v.United States, Court of Claims, decided Nov. 4, 1929. Reviewed by the Board. Decision will be entered under Rule 50.