Atlas Mixed Mortar Co. v. Commissioner

ATLAS MIXED MORTAR COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Atlas Mixed Mortar Co. v. Commissioner Docket No. 33081. United States Board of Tax Appeals 23 B.T.A. 245; 1931 BTA LEXIS 1907; May 14, 1931, Promulgated *1907 There being no showing that the petitioner actually incurred in the taxable years in question the liability to pay out certain amounts set up as reserves for refilling a sand pit, such amounts are not deductible in computing net income for those years. R. W. E. Cole, C.P.A., for the petitioner. R. W. Wilson, Esq., for the respondent. MCMAHON *245 This is a proceeding for the redetermination of deficiencies in income taxes for the fiscal years ended March 31, 1923, and March 31, 1924, in the respective amounts of $1,250 and $1,571.72. The petitioner assigns as error the disallowance by the respondent as a deduction of a reserve for refilling a sand pit. FINDINGS OF FACT. We adopt as part of our findings of fact, verbatim, the stipulation of fact as entered into by the parties at the hearing, as follows: The petitioner is a California corporation, engaged in the sale of building materials, especially in the sale of sand, gravel, mixed mortar, and so forth. During the year 1920, the petitioner entered into a lease agreement with one F. A. McConnell, leasing certain land belonging to said McConnell for a term of fifteen years, for the*1908 sole purpose of excavating sand and gravel deposits therein. The leased property was located within the limits of the City of Vernon, Los Angeles County, California, and in June, 1922, the City Council of Vernon passed an ordinance for the purpose of regulating the removal of sand, gravel, and so forth, from private property within its corporate limits. This ordinance required, among other things, that excavations, except for building purposes, should not be made without securing a permit; that an application for such permit be accompanied by a bond of sufficient amount to cover the cost of reselling [refilling] the proposed excavation; that upon abandonment of the excavating work, the owner or occupant, immediately refill the excavation, and upon failure, negligence, or refusal to refill the excavation within a period *246 of thirty days after the receipt of written notice from the City Clerk, the city might cause the excavation to be refilled and the cost thereof to be satisfied out of the bond. After the adoption of this ordinance, the petitioner duly filed an application on October 23, 1922, for permission to make excavation on the property on which it had already*1909 removed some 43,000 cubic yards of sand and gravel. A bond of $60,000 was filed with the application at that time, and on December 19, 1922, the City Clerk advised petitioner that the application for permission to excavate under the terms of June Ordinance was accepted and permit was granted, and actual excavations occurred as follows: Year Cubic yards Ending March 31, 1921 6,000 Ending March 31, 1922 37,000 Ending March 31, 1923 48,234 Ending March 31, 1924 39,724 Ending March 31, 1925 32,490 Total 163,448 The petitioner, for each of the fiscal years ending March 31, 1923, 1924, and 1925, respectively, charged the sum of $10,000 to profit and loss, crediting same to reserve for refilling the sand pit. At the close of the fiscal year ending March 31, 1925, the petitioner's officers decided that, due to changes in local conditions, the excavations previously made could be refilled at a nominal cost, and accordingly, they transferred from the reserve for refilling the sand pits, the sum of $25,500, which was credited to profit and loss and taken up in income for that year. In the following year ending March 31, 1926, the balance in the reserve was*1910 simply transferred on petitioner's books to profit and loss and included in income. The petitioner's books of account were kept, and its income tax returns duly made, on the accrual basis. The City of Vernon made no demands upon the petitioner to refill its excavation up to the close of the fiscal year ending March 31, 1927, and at that time, only a very small part of such refilling had been done. At a subsequent date, the petitioner arranged with a railroad company which operated in the vicinity of its pit to dump into the excavation, the dirt removed in lowering the grade of its tracks. This arrangement, with dirt secured from other sources, resulted in the pit being completely filled sometime prior to the close of the fiscal year ending March 31, 1929, at no cost to the petitioner. The petitioner received some small income from a few of the firms who desired to use the pit as a dumping ground, which said income was duly included in the taxable income reported by the petitioner. In its return for each of the fiscal years 1923 and 1924 the petitioner claimed a deduction of $10,000. The respondent disallowed the claimed deduction of $10,000 for each of the fiscal years 1923*1911 and 1924 with the following explanation: This amount represents credit to reserve for refilling sand pit. As the reserve was set up to take care of a contingent liability the credit to same is held to represent unallowable deduction. OPINION. MCMAHON: The sole question here presented is whether the respondent erred in disallowing as a deduction from gross income of *247 the petitioner for each of the fiscal years ended March 31, 1923, and March 31, 1924, an amount of $10,000 which the petitioner apparently estimated to be the cost of refilling that portion of the sand pit excavated in each of those years and credited to a reserve. In , we held that a lessee of chattels is not authorized by the Revenue Act of 1918 to take as deductions amounts set aside as reserves each year in anticipation of liability under the terms of the lease to replace the property as good as new when the leased property was returned to the lessor, but that the lessee might deduct only the amounts actually expended or for which liability had actually been incurred during each taxable year. In that case we stated: *1912 * * * Since the taxpayer kept his books on the accrual basis, all deductions allowable in determining his net income should be on that basis, including his contractual obligation under the terms of the lease. In order that an item may be accrued, however, a liability must actually be incurred in the taxable year. . The statute recognized the accrual basis of making returns by providing for the deduction of expenses incurred but not paid. It is apparent that no liability in praesenti was incurred under the terms of the lease in question in the years 1918 and 1919 however well known it might have been that a liability in some amount would be incurred at some time in the future. The liability to restore chattels as good as new or as good as when received when a lease is ultimately canceled or surrendered at some indefinite or indeterminate time in the future is not a present actual liability, and is not the actual incurring of an expense or liability. While it might have been sound business practice on the part of the taxpayer to set up a reserve out of his income to meet a future liability, such a reserve is*1913 not deductible in determining net income. The revenue laws prior to the 1921 Act have never recognized reserves as being deductible from gross income in determining net income except in the case of insurance companies. In the Revenue Act of 1921 specific provision was made for the deduction of reserves for bad debts. If reserves had been deductible under the general provisions of the Act it would not have been necessary to make specific provision for the deduction of particular reserves in the case of insurance companies or for bad debts. The statute specifies what deductions are allowable and, except in the case of insurance companies, no provision is made in the 1918 Act for the deduction of a reserve as such. Items of expense must actually have been paid or liability therefor incurred in order to be deductible under that Act. * * * See also ; ; ; and , all of which cite the Ostheimer case with approval. See also *1914 . The above reasoning with regard to the Revenue Act of 1918 applies with equal force to the Revenue Acts of 1921 and 1924 with which we are here concerned. There are no provisions in those acts *248 allowing this petitioner to take as deductions any amounts, the liability to pay which had not been incurred in the taxable years in which the deductions are sought to be taken. So far as the record shows in the instant proceeding, the petitioner had not incurred any liability in the taxable years in question for the payment of amounts to refill the sand pit. Furthermore, even if we were to assume that there was some liability incurred by the petitioner to pay amounts for refilling the sand pit, or that some expenditure was reasonably certain, and that this liability was admitted by the petitioner, the petitioner would still not be entitled to the claimed deductions, for the reason that it has not shown that the amount which it would have to pay was reasonably predictable or that the amounts claimed were approximately accurate estimates of the liability. See *1915 Reviewed by the Board. Judgment will be entered for the respondent.