Harden v. Commissioner

FRED M. HARDEN AND ESPERANZA P. HARDEN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Harden v. Commissioner Docket No. 98073. United States Board of Tax Appeals 44 B.T.A. 961; 1941 BTA LEXIS 1255; July 9, 1941, Promulgated *1255 To determine whether a citizen engaged in the wholesale tobacco business in the Philippine Islands, who filed no return, is entitled to the benefit of section 251(a), Revenue Acts of 1934 and 1936, because the gross income from the active conduct of trade or business in the Philippines is more than 50 percent of his total gross income, the Philippine tobacco taxes are not a factor in the computation of gross income, but are to be treated as a deduction from gross income. Eugene Meacham, Esq., and Daniel J. Hanlon, Esq., for the petitioners. Arthur L. Murray, Esq., for the respondent. STERNHAGEN *962 The Commissioner determined the following income tax deficiencies and penalties: Year Deficiency in tax 25% penalty 50% penalty 6% interest [1934] $29,663.41 $7,415.85 $14,831.71 $6,638.10 [1935] 45,792.20 11,448.05 22,896.10 7,499.88 [1936] 104,127.72 26,031.93 52,063.86 10,806.46 Total 179,583.33 44,895.83 89,791.67 24,944.44 Claiming the benefit of section 251(a), Revenue Acts of 1934 and 1936, petitioners argue that Philippine excise taxes on tobacco should not be treated as part of cost for computing*1256 gross income from a wholesale tobacco business, and that they were engaged in the active conduct of a business in buying and selling mining shares. Many of the facts are agreed, and the stipulation is made a part of the findings. The Commissioner withdrew the determination of fraud penalties. FINDINGS OF FACT. Petitioners, husband and wife, are citizens of the United States and residents of Amnila, Philippine Islands, where they were married in 1917. 1 During the years 1932 to 1936, inclusive, petitioner received income from the active conduct of a wholesale business in tobacco products; a retail trade in tobacco and pipes; a retail trade in margazines, newspapers, and souvenirs; a retail liquor trade; the opertion of a restaurant and penny weighing scales; and from buying, developing, and selling gold mining claims or leases. He also received corporate dividends and interest of bank deposits. More than 80 percent of his gross income for those years was derived from sources within the Philippine Islands. In the conduct of*1257 the wholesale tobacco business petitioner consummated all sales in the Philippine Islands. Upon goods sold to the United States Army and Navy, the manufacturer allowed petitioner on his purchases a credit of the difference between his cost and expenses and the authorized selling prices of cigarettes to the Army and Navy units in the Philippines. Petitioner's total tobacco sales and the amounts so allowed as credits were as follow: Tobacco sales Credits [1932] [*] 722,457.16 [1933] 430,629.82 [*] 35,881.20 [1934] 695,299.63 42,487.82 [1935] 970,254.39 22,429.12 [1936] 1,560,818.82 50,215.86 *963 The amounts paid the various tobacco companies for tobacco products, including freight-in and insurance; miscellaneous expenses of the business; and Philippine excise or internal revenue specific taxes paid by petitioner to the Philippine Government on tobacco imported and withdrawn from bonded warehouses, were as follows: Paid for tobacco Expenses Taxes [1932] [*] 488,661.02 [*] 91,872.54 [*] 160,974.21 [1933] 275,204.00 50,798.33 64,965.48 [1934] 532,658.60 61,519.49 137,825.72 [1935] 696,339.92 43,925.11 199,507.06 [1936] 1,143,206.28 52,391.91 343,812.40 *1258 The listed taxes were imposed by section 1478 of the Administrative Code of the Philippine Islands, which provides that: Specific internal-revenue taxes apply to things manufactured or produced in the Philippine Islands for domestic sale or consumption and to things imported from the United States or foreign countries * * *. This tax is "in addition to the customs duties, if any", and in the case of imports must be paid "before the release of such articles from the customhouse." In a journal of the tobacco business, items of "general expenses", "merchandise", and "tax" were entered in separate columns and the total in a fourth column. Petitioner's books contain inventories of tobacco on hand as of the beginning and end of each year, and tax is included in the inventory figure. The amounts of the tobacco inventory and of the tax included therein were as follows: Inventory Tax January 1, 1932 [*] 2,460.00 [*] 374.78 December 31, 1932 62,912.74 13,471.48 [1933] 4,756.03 534.60 [1934] 33,360.20 1,625.54 [1935] 5,832.50 386.58 [1936] 13,796.07 1,945.08 The gross income from petitioner's active conduct of other trades or businesses was as follows: *1259 [1936] Restaurant $ 36,253.47 [*] 45,296.87 [*] 38,646.29 [*] 36,927.42 [*] 35,194.38 Retail of tobacco 7,675.93 5,909.79 3,902.60 4,629.81 4,834.47 Magazines, newspapers, etc 528.64 1,753.10 1,538.23 965.06 787.20 Retail of liquor 38.07 Weighing scales 5,065.69 2,453.64 1,066.99 682.30 497.99 Mining claims 22,314.52 44,629.04 44,629.06 310,333.67 In respect of the mining claims, petitioner and others owned claims, known as the Antamok Central Group, which they agreed on December 1, 1931, to sell to the Big Wedge Mining Co. for [*] 500,000, payable *964 in installments. The selling price of petitioner's 43.1875 percent interest was [*$ 188,393.04. He spent [*] 2,200 in the purchase of a one-eighth interest in nine claims; [*] 5,556.31 as patent expenses "in consideration of Icard's giving him 42.1875 percent interest in 14 claims", and [*] 27,730.08 in development of the claims. He received an installment payment of [*] 21,100 in 1931; a payment of [*] 22,314.52 in 1932 and two payments of like amount in 1933 and two in 1934. Payments were impounded by court*1260 order in 1935; the litigation was terminated in 1939 and petitioner received a portion of the payments due. On November 19, 1936, petitioner and J. D. Highsmith sold Elizabeth-Anaconda mining claims for [*] 500,000, petitioner receiving [333,333.67 for his two-thirds interest. On February 1, 1934, he had purchased a one-third interest for [*] 15,000, and on May 7, 1934, a one-third interest for [*] 8,000. He spent [137,916.39 on development and paid [*] 16,666.67 as a selling commission. The foregoing were petitioner's only shares of interest in mining claims and leases during the years 1932-1936. In 1933 petitioner realized gross income of [*] 64,793.47 from sales of shares in five mining companies. He purchased these shares between February 8 and May 23, 1933, for an aggregate of [*] 46,488.07, and sold them between November 10 and 16, 1933, for an aggregate of [*] 111,281.549. During the years 1929-1936 petitioner purchased other shares in mining companies; he made no other sales. Petitioner was not engaged in the active conduct of a trade or business in buying and selling mining shares. Petitioner received the following gross dividends from gold mining*1261 stocks and the following interest: Dividends Interest [1932] [*] 114,736.00 [1933] 215,260.00 [1934] 244,457.00 [1935] 310,857.80 [*] 163.28 [1936] 341,403.00 248.90 Included in dividends of [*] 310,857.80 for 1935 are checks for amounts aggregating $109,452.90 which were mailed from Manila to petitioner and were received by him in the United States. He endorsed the checks and deposited them to his credit in a Los Angeles bank. Two of the checks for amounts aggregating $36,529.05, dated December 20, 1935, were not received by petitioner until 1936; they were deposited on January 18, 1936. The interest was on bank deposits in the United States. Petitioner filed Philippine Government income tax returns, the form of which contained nine schedules for the separate computation of net income from nine sources. For the years 1934, 1935, and 1936 he reported "Income from Business" on schedule B and "Dividends" *965 on schedule G, and left the others blank. Schedule B, as filled in, purports to represent receipts and expenses of several businesses. Values are stated for stock on hand at the beginning and end of the year; and these amounts are*1262 less than the stipulated tobacco products inventories. Among business deductions are "taxes, domestic"; these amounts are greater than the stipulated excise taxes paid on tobacco. The amounts of gross "income from business"; "business deductions"; "dividends"; and the "net incomes" reported on the Philippine returns are as follows: Gross business income Business deductions Dividends Net income [1934] [*] 248,835.70 [*] 281,763.92 [*] 243,974.50 [*] 211,046.28 [1935] 251,099.96 314,575.18 310,375.30 246,900.08 [1936] 726,660.16 641,841.54 342,368.00 427,186.62 The value of the Philippine peso is stipulated to be 50 cents. For the years 1934, 1935, and 1936, petitioner filed no Federal income tax returns. The Commissioner prepared and filed such returns in 1938. He adopted petitioner's "Net income per P.I. return", and made additions or eliminations for conformity with the Federal revenue acts, which did not relate to the treatment of excise taxes on tobacco. The adjusted net income figures of the Philippine returns were then entered as petitioner's gross income on the Federal returns with the following detail: [1936] Loss from business [*] 89,744.54 [*] 54,637.87 [*] 71,063.39 Interest 163.28 248.90 Capital gain 43,760.66 155,882.01 Dividends 243,974.50 310,375.30 342,368.00 Total income 197,990.62 255,900.71 427,435.52 Deductions none none none Net income 197,990.62 255,900.71 427,435.52 U.S. dollars at $0.50 $98,995.31 $127,950.36 $213,717.76 *1263 OPINION. STERNHAGEN: The primary question is whether during the three-year period ending with the close of each taxable year, as provided in section 251(a), Revenue Acts of 1934 and 1936, petitioner, a citizen of the United States doing business in the Philippine Islands, derived 50 percent or more of his gross income from the active conduct of trade or business in the Philippine Islands. Petitioner argues that his gross income from the active conduct of a wholesale tobacco business in the Philippines must be computed without reference to the Philippine tobacco taxes, since those taxes are a deduction in computing net income and are not a factor of gross income. If the petitioner *966 is correct, his taxable income includes only the income from sources within the United States and excludes the income from sources in the Philippines. The petitioner filed no returns for the taxable years, and therefore returns were filed by the collector. In computing a taxpayer's net income, taxes are ordinarily taken as a deduction under section 23(c) of the statute. Regulations 86 and 94, article 23(c)-1, recognized this statutory deduction, and article 23(c)-2 added the qualification*1264 "provided they are not added to and made a part of the expenses of the business or the cost of articles of merchandise with respect to which they are paid, in which case they can not be separately deducted." The collector's return must be regarded as the taxpayer's return and the taxpayer is bound by any statutory elections, ; . If the taxpayer had filed returns and had used his taxes as business expenses or inventory costs, such returns would be binding upon him, ; and if the returns varied from his bookkeeping treatment of the taxes, this variation would not have defeated his right to the method which he used in his returns, . The taxpayer, however, failed to file returns and can not, therefore, be said to have exercised an election to treat these taxes as business expenses or inventory costs for United States income tax purposes. He did not actively take the step which, according to the Commissioner's regulations, impairs his right to the statutory deduction. *1265 Looking at the collector's return and treating it as for all purposes the return of the taxpayer, it still does not appear that this return demonstrates the use of the Philippine taxes as inventory cost. Indeed, the collector's return is so poorly prepared that it can not be reliably used as a basis for the decision. It is said to be prepared in accordance with returns filed by the petitioner with the Philippine Government under the Philippine income tax law. The scheme of these Philippine returns is wholly unrelated to the United States tax and varies so widely from its requirements that it is difficult, if not impossible, to bring it into correlation. Upon the basis of this collector's return, the Commissioner's notice of deficiency was predicated. The facts stated in the notice of deficiency, which ordinarily would serve as the presumptively correct determination, have been put aside by the parties and instead most of the facts have been stipulated. The facts of the stipulation are not the same as the facts in the Philippine return which are imported into the notice of deficiency. This is an unsatisfactory record, and the Board must do the best it can. *967 *1266 The evidence does not require the treatment of Philippine tobacco taxes other than as a normal deduction. The statute provides for such deduction and the Commissioner's regulation is similar, save only where the taxpayer has for tax purposes treated the taxes as expenses of the business or cost of merchandise, "in which case they can not be separately deducted." Plainly this regulation is intended to prevent a double benefit, and prohibits a deduction only if the taxes have already been used as a factor of reducing taxable income. Unless the item has been so used, there is no reason why taxes should not be treated as the usual statutory deduction. There is evidence that in the journal taxes were accounted for in a separate column, and that this column was, like the other two columns of merchandise and expenses, treated as a factor of inventory for the petitioner's private accounting purposes. But it was not transferred to a United States income tax return. On the Philippine returns, deductions for taxes appear clearly, although the amount can not be identified or related to the items now in question. It can not be found that, as the regulations say, the petitioner has for tax*1267 purposes made the taxes a part of the cost of merchandise. They would therefore be separately deductible if a return had been filed. It is held, therefore, that the stipulated amounts of tobacco taxes shall not be used as a factor in the computation of petitioner's gross income for the purpose of determining whether in each three-year period the ratio of gross income from the active conduct of trade or business in the Philippines is more or less than 50 percent of total gross income. As to 1934, it appears that the petitioner had no gross income from sources within the United States, and therefore there would be no deficiency unless the ratio of gross income from active Philippine business proved to be less than 50 percent. This appears not to be so. As to 1935, the factor of [* 64,793.47, derived by the petitioner in 1933 from the sale of mining stocks, which factor is later discussed, may result in the ratio being either more or less than the statutory 50 percent. As to 1936, the ratio of gross income from the active conduct of trade or business in the Philippines is apparently greater than 50 percent. In the present state of the record, a definitive redetermination*1268 can not be made. A recomputation should be prepared upon the basis of the foregoing decision by omitting from the computation of gross income the stipulated amounts of Philippine tobacco taxes and treating those taxes as if they were factors of deduction in arriving at net income. In one week of 1933 the petitioner sold shares in Philippine mining corporations and realized a profit of [*] 64,793.47. He argues that this *968 amount is properly to be regarded as an item of gross income from the active conduct of trade or business in the Philippines, the effect of which would be to improve his 1935 ratio under the 50 percent clause. The evidence, however, does not support his contention. He was not engaged in the business of buying and selling mining shares, and these shares were apparently bought as investments for the sake of the income which they yielded. It does not appear that they had any relation to the conduct of any of his several businesses. These were the only shares which he sold during the entire five years in evidence, and the sales occurred in a single week. They had no relation to the petitioner's activities in connection with the several mining leases*1269 and claims, but were isolated instances incidental to investment, cf. ; ; . The [*] 64,793.47 shall in the computation for the three-year period be omitted from 1933 gross income from the active conduct of trade or business in the Philippines. While in California the petitioner received six dividend checks, amounting to $109,452.90, from corporations in the Philippine Islands, which had been mailed to him in 1935. He deposited the checks in a bank in California. Plainly they were "amounts received by such citizen * * * within the United States", and were, therefore, properly within his taxable gross income under section 251(b). As shown by the findings, although all of the checks were mailed in 1935, two for amounts aggregating $36,529.05 were received by him in 1936. It must be held, therefore, that this amount is to be treated as taxable income of the year 1936 and the remainder as taxable income of the year 1935. The stipulated amounts of interest are within the petitioner's income*1270 from sources within the United States for the respective years, viz., $163.28 in 1935 and $248.90 in 1936. At the hearing the respondent withdrew his determination of fraud penalties, and the recomputation will therefore exclude such penalties. The respondent insists, however, that delinquency penalties should be applied. It is admitted that the petitioner failed to file returns, and the penalty, if any, is therefore mandatory for 1934 and 1935. Were there any showing that the failure to file a return for 1936 was due to reasonable cause, the penalty prescribed by section 291 would not apply. There is, however, no evidence that the failure was due to reasonable cause and not due to willful neglect, and the 25 percent penalty should therefore be added for that year. Decision will be entered under Rule 50. Footnotes 1. There are no considerations which are specifically applicable to the wife, and the word petitioner is herein used to apply to the husband. ↩