Borin Corp. v. Commissioner

THE BORIN CORPORATION, FORMERLY ZERO ICE CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Borin Corp. v. Commissioner Docket No. 90136. United States Board of Tax Appeals 39 B.T.A. 712; 1939 BTA LEXIS 993; April 6, 1939, Promulgated *993 Petitioner entered into a contract to purchase certain machinery, but before the contract was fully performed a second contract was agreed upon and executed whereby the original contract was rescinded and the rights and liabilities of the parties thereunder were canceled. Under the new contract the purchase price for the machinery was substantially reduced and the terms and conditions of the sale differed materially from those contained in the former contract. Held, that petitioner's basis for computing depreciation on machinery and the profit or loss on the sale thereof is to be determined under the terms of the second contract. Bayre Levin, Esq., for the petitioner. Stanley B. Anderson, Esq., for the respondent. TURNER *712 This proceeding involves deficiencies in income tax for the years 1933 and 1934 in the respective amounts of $442.81 and $8,873.63, and excess profits tax for the year 1934 in the sum of $2,909.17. The principal issue is to determine petitioner's cost basis of a certain ice *713 plant for the purpose of computing its depreciation allowance for 1933 and 1934, and its profit or loss on the sale thereof in 1934. *994 In the alternative, the petitioner claims that if the respondent is sustained in his contention as to the basis of the ice plant a credit in the amount of an overpayment for 1932 should be allowed against the deficiencies resulting from such determination. FINDINGS OF FACT. Petitioner is a Michigan corporation, organized on November 5, 1930, with its principal office in the city of Detroit. Its original name of Zero Ice Corporation was changed by amendment of its articles of incorporation to its present name. By a contract dated October 10, 1930, assumed by petitioner upon incorporation, the York Ice Machinery Corporation of York, Pennsylvania, hereinafter referred to as the York Corporation, agreed to sell to Borin Brothers and install and make ready for operation on land to be furnished and improved by the latter, a ten-ton solid carbon dioxide plant for use in the manufacture of solid carbon dioxide gas, commonly known as dry ice, and Borin Brothers agreed to pay therefor the sum of $146,800, of which sum $12,000 was paid upon the execution of the contract and the balance was evidenced by nine interest-bearing notes falling due at various times between June 15, 1931, and*995 October 15, 1932. Under the terms of the contract the York Corporation was required to complete the installation of the plant at its own expense and have it ready for operation on or about March 4, 1931. The York Corporation guaranteed that the "machinery and materials, under test, will be capable of manufacturing ten (10) tons of solid carbon dioxide per day of twenty-four (24) hours when properly and continuously operated in accordance with the instructions of the York Ice Machinery Corporation"; and further guaranteed the "workmanship and materials for one year from the time the said machinery is first put into operation, natural wear, tear and accident excepted; provided no disarrangement of or injury to the machinery be caused by incompetency, carelessness or want of attention, or by the use of improper supplies, and further provided that the said machinery shall have been operated in a proper manner and in accordance with the Contractor's instructions; and in case of any material or workmanship proving defective or insufficient, the Contractor's liability will be limited to repairing or correcting such defects or insufficiencies or furnishing other parts free of charge to the*996 Purchaser." The contract also provided as follows: The Contractor guarantees that the machinery furnished under this contract, under test, with proper insulation as approved by Contractor and operated in accordance with Contractor's instructions, shall be capable of doing refrigerating *714 work as herein specified. All parts and appliances to be furnished by the Purchaser under these specifications shall be suitable for use with Contractor's machinery and materials. The test contemplated by this agreement is one which, if made, shall be under the direction of the Contractor, and it is agreed that no breach of any guaranty, except of workmanship and material, can be shown otherwise than by a test made under its direction while the machinery is yet new, or by competent engineers of the Purchaser, if the Contractor refuses after thirty days' written notice to direct such test. The guaranties and warranties of the Contractor contained herein are not to be treated as conditions, but as collateral undertakings entitling the Purchaser to all direct legal damages but not to consequential damages for their breach. If for a period of thirty days immediately after the machinery*997 and materials furnished hereunder are delivered or erected ready to charge, as the case may be, the Purchaser shall fail to notify the Contractor in writing of any claim that the said machinery and materials as furnished do not fulfill the terms and requirements of the contract, specifying in what particular or particulars they fail, this shall, in itself, be considered an acknowledgement by the Purchaser that the said machinery and materials as furnished do fulfill the said terms and requirements, and shall constitute a complete acceptance of the same as fulfilling all the terms and requirements of the contract relating thereto. * * * * * * It is expressly understood that this proposal contains all of the agreements between the parties hereto pertaining to the machinery and materials to be furnished hereunder, and that there is no verbal understanding whatever between the parties in reference thereto, and that there are no special facts or circumstances affecting the liability of the parties not stated herein. It is further understood and agreed to by the Purchaser that no workman, agent, employee or representative of the Contractor shall have any power or authority by anything*998 said, written or done to bind the Contractor in any manner, or to waive or change any of the provisions of this contract or other legal right of the Contractor without written authority therefor duly executed by one of the Contractor's general officers. * * * The petitioner prepared the land and foundation for the installation of the plant and purchased distribution equipment, liquifiers, and other necessary equipment. The plant was delivered, installed and ready for operation in the month of May 1931. It was operated intermittently during that month and part of June and on the basis of its performance, which seemed to be satisfactory, it was accepted by the petitioner. Thereafter the demand for the product became constant enough to require the continuous operation of the plant and under such operation it was found that there were repeated interruptions, and dry ice of the quantity and quality desired could not be produced. During the summer of 1931 the petitioner made many complaints to the York Corporation on account of the unsatisfactory operation of the plant. The problem was primarily a matter of adjustments. The quality of the product was poor, due to the presence*999 of oil, rust, *715 and foul gas, but the principal complaint was that the quantity of dry ice produced was insufficient. As a consequence of the complaints the York Corporation sent engineers into the plant from time to time and with their assistance its operation was continued throughout the summer of 1931, but production still was not satisfactory. In March 1932 an arrangement was made whereby the York Corporation agreed to operate the plant at its own expense until such time as it could demonstrate that the plant, when properly operated, would produce the product in conformity with the guaranties set forth in the contract. For the dry ice produced during such test period the petitioner was to pay the York Corporation one cent per pound. After certain adjustments and minor replacements the operation by the York Corporation demonstrated that the plant would produce as much as ten tons of dry ice per day of acceptable quality, and petitioner was satisfied that it would operate in conformity with the guaranties in the contract. The York Corporation accordingly withdrew its agents from the plant and the petitioner resumed operation thereof. For a number of years prior*1000 to the organization of the petitioner. the three Borin brothers, who owned most of the stock in petitioner, had been in the water ice manufacturing business and had pruchased from the York Corporation several hundred thousand dollars worth of equipment. The equipment purchased included about six complete water ice plants, which from time to time required replacement. The petitioner's general manager, Almon J. Cordrey, was a former sales representative of the York Corporation and had assisted in laying out the above mentioned water ice plants. He also negotiated the sale to the petitioner of the dry ice plant involved in the present controversy, which was the first dry ice plant designed and manufactured by the York Corporation. Shortly after the petitioner was organized he became its general manager. The relationship between the Borin brothers and the York Corporation had always been very friendly. Because of the unsatisfactory operation of the plant the petitioner had refused to make any of the deferred payments under the contract and on December 31, 1931, by proper entries on its books, it charged back to the York Corporation unpaid notes amounting to $134,800; also $12,000*1001 representing the amount of cash paid at the time the contract was executed. The companion entries were credits to machinery and equipment. Also under date of December 31, 1931, it debited the York Corporation in the amount of $21,954.61, as the amount of the operating losses sustained from the installation of the plant to the date of the entry. The companion entry was a credit to *716 surplus. Subsequently under date of February 29, 1932, a charge of $6,555.13 was made on petitioner's books to the York Corporation to represent operating losses from January 1, 1932, to the date of the entry. On some date undisclosed but prior to the time the plant was satisfactorily operated the York Corporation made a loan to petitioner in the amount of $10,000. From the month of March 1932 until the fall of the same year, conversations and negotiations were carried on between representatives of the York Corporation and the petitioner with respect to petitioner's claim for damages. Most of these negotiations were carried on between S. E. Lauer, general sales manager of the York Corporation, and Almon J. Cordrey. At some time during this period a representative of the York Corporation*1002 made an examination of petitioner's books. In the fall of 1932 the negotiations culminated in an understanding that the York Corporation would allow an adjustment on the transaction in the total sum of $84,800, arrived at as follows: Interest on investment of Zero Ice Corporation in building and equipment of $84,882.31 for an average of 1 1/2 years at 9% of total $7,639.40 Interest on advances to York Ice Machinery Co. to September 1, 1932 1,390.77 Additional interest for one month to October 1932 69.30 9,099.47 Normal depreciation of plant in controversy to average of 1 1/2 years at 15% per annum of 22 1/2% of $146,800 33,030.00 Extraordinary additional defalcation on boilers, double pipe equipment and compressors 4,000.00 Net loss to October 1, 1932 (accepted for convenience as date of settlement): Amounts charged on books of the Zero Ice Corporation: To December 31, 1931 $22,054.61 To February 29, 1932 6,555.13 Net Loss from March 1, 1932, to October 1, 1932, and unallocated element of damages arbitrarily agreed to compensate for lost profits in order to make even amount of $84,800 10,060.79 38,670.53 Total amount agreed upon as damages and set off against balance of liability of $134,800 84,800.00 *1003 It was at first thought that the difference between the petitioner and the York Corporation would be settled by a credit in the amount of $84,800, agreed upon, against petitioner's liability under the original contract. After consideration of the matter, however, the York Corporation expressed the desire to dispose of the matter through the execution of a new contract which would definitely fix the liabilities and rights of the parties with respect to the said machinery. This proposal was agreed to by the petitioner and under date of November 7, 1932, a new contract was entered into which provided that the *717 contract of October 10, 1930, "is herebt rescinded, and the rights of the parties under the said contract or arising out of the same are hereby mutually cancelled." Under the terms of the new contract the York Corporation agreed to sell the solid carbon dioxide plant hereinbefore referred to for the sum of $72,467, and the petitioner agreed to buy the said plant and to pay $12,000 upon the execution of the agreement, the receipt of which was acknowledged by the York Corporation, and the remaining $60,467 in installments of various amounts falling due from time to*1004 time between June 15, 1933, and December 15, 1934, and bearing interest at the rate of 6 percent. The sum of $72,467 to be paid was arrived at by subtracting from the original contract price of $146,800, the amount of losses claimed by the petitioner in the sum of $84,800, and by adding thereto $10,467 which represented the $10,000 loan previously made by the York Corporation to the petitioner and $467 interest thereon. The $12,000 previously paid bt petitioner was treated as the cash payment required upon execution of the new contract. The contract provided that the plant would remain the personal property of the York Corporation until the entire purchase price was paid and provisions were made for repossession in case of default. The guaranties and warranties contained in the contract of October 10, 1930, hereinbefore set forth, were omitted from the new contract except that the York Corporation guaranteed the workmanship and materials for one year from the date of the agreement. In computing its depreciation deduction on the plant for 1933 and 1934, petitioner used as its basis the sum of $146,800, the purchase price recited in the contract of October 30, 1930. The plant*1005 was sold in 1934 and the same basis was used in computing the profit therefrom. In its return for 1932 the petitioner reported no income with respect to any of the adjustments made in that year between it and the York Corporation in the matter of the purchase of the ice plant heretofore described. On February 26, 1935, petitioner filed an amended return for 1932 and reported therein the receipt of additional income in the sum of $57,482.44, designated as profit realized in 1932 on the said transaction which culminated in the execution of the contract of November 7, 1932. In connection with the filing of the amended return petitioner paid the tax shown thereon in the principal sum of $3,999.29, together with interest in the amount of $479.91. The respondent has determined that petitioner's deprecistion allowance for 1933 and 1934 should be computed on a cost basis of $62,000, representing the total sum of $72,467 recited in the contract of November 7, 1932, minus the $10,000 loan and $467 interest included therein. He has determined that petitioner's profit on the sale of the plant in 1934 should be computed on the same basis. *718 OPINION. TURNER: The petitioner*1006 contends that the basis for computing the depreciation deduction on its plant and the profit realized upon the sale thereof is $146,800, the purchase price recited in the contract of October 10, 1930, and that the contract of November 7, 1932, contrary to its expressed terms, was not a contract of sale but was a supplemental contract entered into for the purpose of effecting the payment of damages to petitioner and the crediting of the damages so paid on the purchase price of the plant, which remained and continued to be $146,800 as originally agreed. In support of its claim the pettioner has offered various documents and the testimony of witnesses for the purpose of showing that the warranties in the contract of October 10, 1930, were breached through the failure of the plant to produce dry ice of the quantity and quality prescribed, that substantial damages were thereby sustained, the amount of which was negotiated, determined, and agree upon by the petitioner and the York Corporation, and that the contract of November 7, 1932, did nothing more than state the balance due between them, the amount so stated being the purchase price of the plant as shown by the contract of October 10, 1930, less*1007 the damages agreed upon and plus $10,467 representing the amount of a loan and the interest thereon then due and owing by the petitioner to the York Corporation. The respondent, on the other hand, claims that the contract of November 7, 1932, expressly rescinded the contract of October 10, 1930, and effected the sale of the plant to petitioner at a price and on terms entirely different from those expressed in the earlier agreement and accordingly the basis to the petitioner for computing the depreciation deduction and the profit upon the subsequent sale of the plant is the purchase price finally agreed upon and reflected by the contract of November 7, 1932. With respect to the contention of the petitioner, the respondent, calling attention to the description of the items composing the sum of $84,800, the amount by which the purchase price of the plant was adjusted, advances the proposition that the said sum may not properly be termed damages under the contract of October 10, 1930, since that contract provided for direct damages only and consequential damages were expressly excluded, the obvious inference being that the York Corporation, though not liable for damages, but realizing*1008 and recognizing the difficulties which had been encountered by its first purchaser of dry ice machinery, had agreed in the contract of November 7, 1932, to a reduced purchase price for the plant. The record discloses certain facts which give color to the proposition as stated. Under the contract of October 10, 1930, the contractor, *719 the York Corporation, guaranteed workmanship and materials for one year provided the machinery was operated in accordance with its instructions. It also guaranteed that the machinery so furnished would "under test", when operated in accordance with its instructions, be capable of producing ten tons of solid carbon dioxide per day of 24 hours. It was further stated that the "test" contemplated by the agreement was to be made under the direction of the contractor and that no breach of the guaranty, except with respect to workmanship and materials, could be shown other than by such "test." If the purchaser failed to notify the contractor in writing within a period of thirty days of any claim that the plant did not fulfill the terms and requirements of the contract, such failure was to constitute a complete acceptance thereof. It was expressly*1009 provided that the guaranties and warranties were not to be treated as conditional "but as collateral undertakings entitling the purchaser to all direct legal damages but not to consequential damages for their breach." The petitioner not only filed no notice within thirty days that the plant did not fulfill the terms and requirements of the contract, but, to the contrary, accepted the plant and, while there were numerous complaints thereafter, it also appears that upon operation "under test" by the York Corporation using its own employees the plant did, with minor adjustments and replacements, produce dry ice of the quantity and quality guaranteed and its performance in that respect was accepted and acknowledged by the petitioner. It also appears that even though the sum of $84,800 as damages was agreed to by the York Corporation, many of the items making up that sum may not reasonably be classified as direct damages as contrasted with consequential damages. To illustrate: $7,639.40 is described as interest on the investment of petitioner in buildings and equipment for the period of unsatisfactory operation; $1,390.77 is designated as interest on amounts previously paid to the York*1010 Corporation, presumably toward the purchase price of the plant; $33,030 is classified as depreciation; while $10,060.79 is described as an amount agreed upon to compensate for loss of profits. It is difficult to see how these items, under the circumstances, might be classified as direct damages provided for by the contract of October 10, 1930, instead of consequential damages which were expressly excluded. In the view we take of the case, however, that question is not present. Williston on Contracts, vol. III, par. 1826, states: Also, "A subsequent contract completely covering the subject matter, and made by the same parties, as an earlier agreement, but containing terms inconsistent with the former contract, so that the two contracts cannot stand together, rescinds, substitutes, and is substituted for the earlier contract and becomes the only agreement of the parties on the subject." . *720 In , the Court quoted from *1011 , to the effect that: If the claimants had any objection to the provisions of the contract they signed, they should have refused to make it. Having made it and executed it, their mouths are closed against any denial that it superseded all previous arrangements. In ; , the court quoted from Black on Rescission and Cancellation (2d Ed.) § 8, as follows: Since it is always in the power of the parties to a contract to rescind or abrogate it by their mutual consent, they may accomplish this result by the substitution of a new contract, implying a mutual discharge from reciprocal obligations under the original contract and the restoration of the status quo or compensation for altered conditions, provided that the new contract shall be complete and binding in itself, and shall embrace each and all of the parties to the original contract. Furthermore, it is legally possible to have mutual cancellation of an executory contract notwithstanding the contract has been partially performed. *1012 ; ; ; . In the instant case the contract of November 7, 1932, contained the expressed provision that the contract "executed under date of October 10, 1930, is hereby rescinded, and the rights of the parties under the said contract or arising out of the same are hereby mutually cancelled." It also contains a provision whereunder the York Corporation agreed to sell and did sell the plant to the petitioner at a price and under terms which were entirely different from those fixed by the contract of October 10, 1930. Furthermore there appears to be no question that the amount actually paid by petitioner to the York Corporation in respect of the purchase of the said plant was the amount fixed by the contract of November 7, 1932. In the light of the authorities referred to we conclude and hold that the basis to the petitioner for the computation of its depreciation deductions herein and the profit derived from the sale of the plant is to be determined under the new contract. Of the amount of $72,467*1013 therein stated, $10,467 admittedly represented a loan by the York Corporation to petitioner and the interest thereon. There is no contention that these items of loan and interest represented part of the purchase price of the plant. On these facts it must be concluded that the York Corporation poration sold the plant in question to the petitioner for the sum of $62,000 and that amount is its basis for determining its depreciation allowance and gain or loss upon sale. *721 In the alternative the petitioner claims that the allowance of a credit in the amount of the claimed overpayment made on its amended return for 1932 should be directed against any deficiency determined herein. The amount paid on the basis of that return resulted from the inclusion in income for 1932 of a certain amount as gain realized by petitioner in connection with the adjustment agreed upon by it and the York Corporation on the purchase price of the dry ice plant. Congress has dealt with such claims in section 820 of the Revenue Act of 1938 and relief with respect thereto must rest on the applicability of that section. Decision will be entered under Rule 50.