East Coast Motors, Inc. v. Commissioner

EAST COAST MOTORS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. East Coast Motors, Inc. v. Commissioner Docket No. 74227. United States Board of Tax Appeals 35 B.T.A. 212; 1936 BTA LEXIS 550; December 23, 1936, Promulgated *550 1. Where the taxpayer failed to obtain the respondent's approval to change its accounting period from a fiscal year to a calendar year for the reason that it did not comply with the provisions of article 361 of Regulations 74, the respondent did not err in refusing permission to make the requested change in its accounting period. 2. Where the taxpayer accrued at the end of the fiscal year (ended July 31, 1931) bonuses to the account of employees pursuant to an agreement to pay them bonuses out of net profits, if any, at the end of the calendar year (December 31, 1931) there was no liability to pay the bonuses nor could the amount be determined at the end of the fiscal year. Held, bonuses accrued at the end of the fiscal year are not deductible. W. H. Harris, Esq., for the petitioner. O. W. Swecker, Esq., for the respondent. HARRON *212 This proceeding is for the redetermination of a deficiency determined by the respondent for the fiscal year ended July 31, 1931, in the sum of $635.26. Petitioner has filed a claim for refund in which it is set out that the amount of $97.61 was erroneously paid by the petitioner at the time of filing*551 its income tax return for the taxable period involved herein. Two issues are raised by the pleadings, as follows: (1) Whether the petitioner is entitled to file its income tax return for the year 1931 on a calendar year basis instead of for the fiscal year ended July 31, 1931; and (2) whether the respondent erred in disallowing as a deduction from gross income the sum of $5,662.61 representing additional compensation to its employees in the form of bonuses accrued on its books as of July 31, 1931. FINDINGS OF FACT. East Coast Motors, Inc., located at West Palm Beach, Florida, was incorporated under the laws of the State of Florida in 1925 for the purpose of selling and servicing Buick automobiles. Its business was that of an authorized retail agency of the Buick Motor Co. In January 1931 the individuals who operated the business of the petitioner corporation and who held its outstanding stock desired to transfer to another part of the country and dispose of the Buick agency for West Palm Beach. The Buick Motor Co. made an oral agreement with Arthur W. Huguley whereby he agreed to take over the agency, but it was considered preferable to continue the agency under the name*552 of East Coast Motors, Inc. At the beginning of the fiscal year *213 the capital stock issued and outstanding consisted of 5,000 shares of preferred and 38,500 shares of common, each having a par value of $1. The change in the agency was effected without any formal written agreement in the following way: At the annual meeting of stockholders of the petitioner, held January 30, 1931, one stockholder held all of the outstanding common and preferred stock endorsed in blank. A resolution was adopted authorizing the corporation to repurchase from certain stockholders, through their assignee, 19,248 shares of common stock and 5,000 shares of preferred stock in exchange for certain described assets of the corporation. These assets were valued at $38,513.05, and there were to be assumed by the retiring stockholders liabilities totaling $15,309.93, so that the net assets exchanged for stock were valued at $23,203.12. There remained in the corporation other physical assets inventoried at a value of $19,451.68. There remained outstanding 19,252 shares of common stock. On January 23, 1931, Huguley paid $1,000 to the Buick Motor Co. as payment on account of taking over the Buick*553 agency for West Palm Beach. Later this was distributed to the retiring stockholders. On January 30, 1931, Huguley paid one of the stockholders representing the retiring stockholders, $18,451.68. Later, Huguley paid $7,248 into the corporation. There were issued to him, in the name of his trustees, 26,500 shares of common stock of the petitioner corporation. Huguley carried on his negotiations with a representative of the Buick Motor Co. and through him the negotiations were consummated. Thereater, Huguley, through his nominees, owned all the outstanding stock of the petitioner corporation and became president. No changes were made in the corporate name, charter, bylaws or business of the petitioner corporation. Its business was continued by the new stockholders. A new set of books was opened February 1, 1931, clear of the liabilities transferred to the retiring stockholders. A new corporation was not formed. No application for a new charter was filed with the State of Florida. The petitioner corporation was not dissolved or liquidated either before or after Huguley became president. The minutes of the annual meeting of stockholders, held January 30, 1931, made no reference*554 to liquidation, dissolution or the creation of a new corporation. On February 2, 1931, the East Coast Motors, Inc., by its president, A. W. Huguley, entered into a written agreement with Earl S. Collins, which provides in part as follows: The Corporation [petitioner] employs the salesman or manager [Collins], and the salesman or manager agrees to act as salesman or manager for the corporation from the 31st day of January, 1931 to the 31st day of December, 1931; and thereafter until this agreement shall be terminated in the manner hereinafter provided. * * * The *214 salesman or manager shall be entitled as compensation for his services the salary of Forty ($40.00) Dollars per week, and the corporation further agrees in addition to the weekly salary as heretofore specified to pay the salesman or manager further consideration for such services, a bonus on the yearly net profits, if any, of the business of the corporation of twenty-five (25%) per cent of the net profits after other employees bonuses have been paid. This agreement shall be for a term of 11 months from the date hereof, but may be renewed year after year as hereinafter provided. Such contract was*555 ratified and confirmed at a meeting of the board of directors of the corporation held on March 30, 1931. Oral bonus agreements with other employees were also entered into, which were likewise contingent upon the realization of net profits. The bonuses were accrued on the books of the corporation each month. An entry was made in the journal as of July 31, 1931, which debited to surplus and credited to the bonus payable account the sum of $5,662.61, which included a bonus accrued to Collins. During the latter part of the calendar year 1931 the corporation lost considerable money and at the end of the year Huguley told the employees that the corporation could not pay the bonuses because they had not been earned. All of them, except Collins, relinquished any claims they might have had. Collins, who was discharged by Huguley in November 1931, made claim for a bonus under the agreement. No specific amount was claimed, Collins expecting to base his claim upon what the corporation's books showed. By written instrument dated February 20, 1932, Earl S. Collins, in consideration of $100 cash, released the corporation from any and all liability under his bonus agreement and any other liabilities*556 to him. On February 24, 1932, the corporation, in consideration of such release, released Earl A. Collins in full of the open account charged to him on the corporation's books. With the exception of the amount paid to Collins, no other amounts were paid under the bonus agreements. Prior to the year 1931 the income tax returns of the East Coast Motors, Inc., had always been filed on the basis of a fiscal year ended July 31. On February 9, 1931, it filed a request with the respondent to change its taxable year from a fiscal year ending July 31 to a calendar year basis. This request was denied by respondent by letter dated March 3, 1931, wherein it was stated in part: In reply you are advised that article 361 of Regulations 74 under the Revenue Act of 1928 provides that if a corporation desires to change its accounting period it shall, prior to the expiration of thirty days from the close of the proposed period for which a return would be required to effect the change, furnish the collector of internal revenue for transmission to the Commissioner, the information requested on Form 1128. Therefore, since your request was not made until February 9, 1931, it was made too late to*557 make the change effective as of December 31, 1930. *215 If, however, you desire to make the change as of December 31, 1931, it will be necessary for you to fill out the enclosed Form 1128 and to file it with the collector of internal revenue for your district not later than January 30, 1932. Your attention is directed to the printed instructions on the back of the form, particularly the requirement with respect to the signature when filed by a corporation. Your attention is directed to the fact that your return for the full fiscal year ending July 31, 1931, will be due on or before October 15, 1931. Upon receipt of your application from the collector it will be given further consideration. Thereafter, on October 15, 1931, the corporation filed a return for the fiscal year ended July 31, 1931, showing a tax liability of $97.61 which was duly paid. On March 31, 1933, the corporation filed an amended return for the calendar year ended December 31, 1931, which disclosed no tax liability. On this same date there was filed a claim for refund in the amount of $97.61 in which it was set out that the corporation's return for 1931 should have been filed on the basis of*558 a calendar year. In its return filed for the fiscal year ended July 31, 1931, the petitioner claimed as a deduction the amount of $5,662.61 representing the bonuses claimed to be payable. In the notice of deficiency the respondent disallowed this deduction on the ground that such amount did not accrue as a liability during the taxable year. The respondent also determined that the correct basis for reporting income is for the fiscal year ended July 31, 1931, rather than for the calendar year 1931, for the reason that there was no change in the corporate entity during the fiscal year ended July 31, 1931, and for the further reason that there was no authority obtained from the Commissioner for changing the accounting period. The petitioner corporation kept its books and made its returns upon an accrual basis. OPINION. HARRON: In support of its allegation that the respondent erred in refusing its request to change the accounting period from a fiscal to a calendar year basis, petitioner contends that after January 31, 1931, it became a new taxable entity and that it consequently had the right to elect to compute its net income and file its tax returns on the basis of a calendar*559 year. It is pointed out that if this contention is sustained the issue disappears with respect to deduction from gross income of bonuses accrued to employees at the end of the fiscal year. Petitioner is a corporation, organized under the laws of the State of Florida. It is an elementary principle that a corporation is a legal entity separate from its stockholders. About January 31, 1931, W. A. Huguley invested money in the stock of the petitioner corporation *216 and became its new president. He was undertaking a new business venture. But the corporation was not entering into any new business, nor do we find from the evidence that it became a new corporation or a new taxable entity. No change was made in the corporate name, charter, bylaws or business of the corporation on or after January 31, 1931. The sale of part of its assets to retiring stockholders resulted in nothing more than a reduction of its capital assets and a change in its stockholders. The argument of petitioner advances a theory that the entire transaction liquidated the petitioner corporation and that a new corporation came into being in substance, although without going through the usual formal procedure. *560 However, we are unable to find in the minutes of the corporation submitted any evidence of intent of the retiring stockholders to effect a complete liquidation and the various steps followed throughout the transaction do not support this theory. There is no evidence to show exactly what Huguley received for his payment of $19,451 to the retiring stockholders, but such payment appears to have been made for the 19,252 shares of stock still outstanding rather than for an inventory of assets. There was no bill of sale from the corporation to Huguley to evidence his purchase of the remaining assets of the corporation in liquidation in support of his contention to that effect. Furthermore, petitioner corporation did not resort to the procedure provided in article 391 of Regulations 74 for the filing of a final income tax return on liquidation of a corporation. The petitioner's argument is directed at length to the theory that if we look "through form to substance" we will reach the conclusion that a new corporation or a new taxable entity resulted from negotiations set forth in the findings of fact. After reviewing the evidence submitted and the authorities cited by the petitioner*561 to sustain the theory advanced, we find that neither this argument nor the authorities cited are persuasive in the instant proceeding. To agree with petitioner's theory would be to assume the existence of facts which the evidence does not show to exist. From review of the evidence submitted, we find that the petitioner corporation continued to be the same corporation and the same taxable entity after January 31, 1931. There is a further question of whether respondent erred in refusing petitioner's request to change its accounting period from a fiscal to a calendar year basis. Petitioner had filed its returns on a fiscal year basis for several years prior to the taxable year. It was, therefore, required to obtain consent of respondent to change its accounting period by the provisions of section 46 of the Revenue Act of 1928. Article 361 of Regulations 74 sets forth the procedure to be followed by a taxpayer in obtaining permission to change its accounting period. Petitioner filed its request February 9, 1931, which was several days *217 after the time prescribed by the pertinent regulation. Since the petitioner failed to comply with the regulations of the Commissioner, *562 we find that respondent was not in error in refusing, at the time, permission to change the accounting period. See . The instant proceeding is distinguishable from and , cited by the petitioner. Furthermore, there is no evidence to show that the annual accounting period (fiscal year) employed by the petitioner to compute net income did not clearly reflect income within the provisions of section 41 of the Revenue Act of 1928. The fact that certain bonus agreements with employees were for the calendar year is not material to the contention that it was necessary for petitioner to change its accounting period to a calendar year basis. There remains the further question of whether or not the petitioner is entitled to deduct from gross income the amount of $5,662.61. This sum petitioner accrued to its surplus account as bonuses payable to employees at the end of the fiscal year. We hold that respondent is not in error in disallowing this deduction for the reason that the amount of bonuses payable to employees*563 could not be determined at the close of the fiscal year and because no liability to pay the bonuses arose during the taxable year. The written bonus agreement with Collins and the oral bonus agreements with other employees were for a term of eleven months from February 2, 1931. The payment of bonuses was made contingent upon the existence of "net profits, if any" at the end of the calendar year 1931. Collins was to receive 25 percent of the net profits after other employees' bonuses had been paid, but no evidence was introduced to show what percentage of net profits was to be paid to individual employees. Consequently the method of computing the individual amounts of bonuses accrued to certain employees totaling $5,662.61 as of July 31, 1931, is not clear. There was no liability in the petitioner to pay bonuses to employees until net profits existed as of the close of the calendar year 1931. The rule has been established that "except as otherwise provided by statute, a liability does not accrue so long as it remains contingent." See *564 . See also ; affirmed in ; ; . Judgment will be entered for the respondent.