Wisconsin Ornamental Iron & Bronze Co. v. Wisconsin Tax Commission

The following opinion was filed March 4, 1930: Owen, J. The Wisconsin Tax Commission made a field audit of the books of the Wisconsin Ornamental Iron & Bronze Company, hereinafter called the Taxpayer, for the — 357 — years 1921 to 1927, both inclusive, resulting in a proposed additional assessment of income, of which notice was given to the Taxpayer, and upon objections made by it to such proposed additional income tax a hearing was had before the Tax Commission in due course, resulting in the final imposition of an additional income tax for those years. The Taxpayer is largely engaged jn the manufacture and erection of iron and bronze products for building-construction purposes. At the end of each fiscal year there are a number of contracts which are only partly completed. Under its system of accounting the Taxpayer deferred on its books all profit or loss on these contracts until they were completed. Its income tax return did not disclose any income from a contract until it was completed. Its income tax returns were made in accordance with this system of accounting to the Wisconsin Tax Commission during the years in question by and with the consent of the commission. The principal controversy here involved will be clearly revealed by some correspondence between the Tax Commission and its auditor. On January 5, 1928, the auditor wrote the Tax Commission as follows: “Re Wisconsin Iron & Wire Works: Kindly give me a ruling on the following situation: The company manufactures and installs under job contracts iron and bronze fixtures. At the close of any one year there are a number of jobs in process of manufacture or installation on which no profit is computed. It is the practice to bill customers for materials shipped at the close of each month, the charge being to accounts receivable and the credit to sales. At the close of the year an analysis of the sales account is made and only those sales are closed into profit and loss which represent completed contracts, the balance remaining as a credit in the account. Likewise an inventory of the goods in process of incompleted contracts is set up regardless of whether the goods have been shipped and billed. “It is our contention that, when parts of a job have been completed and the customer billed, and in some cases even — 358 — large amounts of payments received, a sale has been consummated and profit should be computed. Customers are billed at the close of the month for the entire amount of the shipments to date. However, the contracts allow them to withhold payment of fifteen per cent, of the building until the job is completed.” To this the Tax Commission replied as follows: “After going over the information submitted we think you will be perfectly within your rights as well as observing correct accounting principles if you will require the company to accrue upon their books at the close of any year all portions of contracts which have already been shipped to the purchaser. We feel that there can be no question as to the fact that these sales of completed portions of a contract should properly be accrued. The withholding of fifteen per cent, of the billing price by the purchaser will in no' way affect the accrual of this item. It might be possible that the goods in process which is being manufactured on contract- or order but which is still in the company’s possession and in the process of manufacture might be accrued, at least a portion thereof, during the year, but we believe it would be best to let this particular item remain as goods in process inventory, and to accrue only such amounts or units as have actually been completed and have been shipped to the customer whether billed or not.” The auditor proceeded with his audit by treating as income the amount of the billings in accordance with his original suggestion, by reason of which the taxable income of the Taxpayer was increased for a six-year average by about ten per cent. The legality of the tax imposed upon this increased income affords the principal controversy we are called upon to consider. The Taxpayer insists that its method of accounting is sanctioned by the best accounting practices, is supported by practically all accounting authority, and assails as utterly unjustifiable, and as unsupported by any recognized accounting theory, the method employed by the auditor of the Tax — 359 — Commission in arriving at the increased income contributing to the increased assessment complained of. Whether this presents a controversy calling for our determination depends upon the nature of the report which the statute requires of the taxpayer and the character of the discretion lodged with the commission to accept a modified form of such report. For a determination of this question we must consider generally the scope and purpose of the income tax act and, specifically, sec. 71.02 (3) (a), which provides: “Persons who customarily estimate their incomes or profits on a basis other than cash receipts and disbursements may, with the consent and approval of the tax commission, return for assessment and taxation the income or profits earned during the income year, in accordance with the method of accounting regularly employed in keeping their books, except as hereinafter provided; but if no such method of accounting has been employed, or if the method used does not clearly reflect the income taxable under this chapter, the computation shall be made upon such basis and in such manner as in the opinion of the tax commission will clearly reflect such income.” From a consideration of the income tax act as a whole, the legislative purpose to impose an income tax upon annual gross income less deductions authorized by the act is clear. Any system of accounting by which the income or the profits of the taxpayer is arrived at on a basis of cash receipts and disbursements complies with the requirements of the act. A taxpayer who is able to report his income upon this basis meets with no difficulties. The legislature recognized, however, that modern scientific accounting methods do not always accommodate themselves readily to a report of income computed on such basis. No doubt a realization of this fact prompted the enactment of the statute above quoted by ch. 65, Laws of 1921. The question is, Does this create a right in the taxpayers to report their incomes in accordance with the methods of accounting regularly employed in keep — 360 — ing their books, or is it a mere concession dependent upon the approval of the Tax Commission? In U. S. v. Anderson, 269 U. S. 422, 46 Sup. Ct. 131, in which an act of Congress similar to this statute was under consideration, we find these observations: “This section went further than any previous regulation by authorizing the tax return to be made on the basis on which the taxpayer’s books were kept, provided only that the basis was one reflecting income and the' return complied with regulations made by the commissioner. ... It was to enable taxpayers to keep their books and make their returns according to scientific accounting principles, by charging against income earned during the taxable period the expenses incurred in and properly attributable to the process of earning income during that period; and indeed, to require the tax return to be made on that basis, if the taxpayer failed or was unable to make the return on a strict receipts and disbursements basis.” The question there under consideration was whether certain taxes were properly deductible from the income of 1917, during which year the taxes were paid, or whether they were deductible, in accordance with the regulations of the commissioner, from the income of 1916, during which year they accrued. It was held that the regulation of the commissioner requiring their deduction from the income of 1916, during which year the taxes accrued, was in accordance with the statute. While the question there involved was not identical with the one here presented, nevertheless we gather from the. opinion that the court was of the view that ah exact compliance with the income tax- act required a report made upon the basis of cash receipts and disbursements, and that where the report was made upon any other basis it must clearly reflect income and the return must comply with regulations made by the commissioner. The opening phrase of the statute above quoted reflects the legislative thought that an exact compliance with the — 361 — income tax act requires a report made upon the basis of cash receipts and disbursements. It also seems to recognize that many taxpayers do not estimate their incomes or profits on that basis. It then authorizes them to maké a return of the income or profits earned during the income year according to the method of accounting regularly employed in keeping their books. This, however, can only be done with the consent and approval of the Tax Commission. Neither can it be done if the method used “does not clearly reflect the income taxable under this chapter.” It seems plain that the basic requirement of the law is a report of income based upon the cash receipts and disbursements. To report upon any other basis is not the right of the taxpayer, but is a mere concession conditional upon the approval of the Tax Commission, and further conditional that it shall “clearly reflect the income taxable under this chapter.” Here the Taxpayer has no absolute right to continue to make its return of income in its customary manner. In the first place, it is exceedingly doubtful whether that method clearly reflects its income taxable under the act. Whether the method reflects the “average net income” now required we do not pause to consider. But that under the prior provision of the act it did not reflect the income received during any one year seems certain. But whether it does or not, its return cannot be made in the manner followed by the Taxpayer in the absence of the approval of the commission, because it is not upon the basis of cash receipts and disbursements. It therefore seems unnecessary for us to consider the various objections which the Taxpayer makes to the method employed by the field auditor in making the additional assessment. As it does not customarily estimate its income or profits on the basis of cash receipts and disbursements, it must submit to a computation upon such basis and in such manner as in the opinion of the Tax Commission — 362 — will clearly reflect such income. There is no escape from this conclusion so far as it relates to the future income tax. Whether that portion of the additional assessments growing out of the application of the method adopted by the auditor should be permitted to stand, involves a further consideration. It was held in State ex rel. Schuster Realty Co. v. Wis. Tax Comm. 184 Wis. 175, 197 N. W. 585, 199 N. W. 48, that an assessment made upon a return showing all the facts' was final and conclusive, and that an additional tax could not be levied because the commission had arrived at a different conclusion concerning a proper rate of depreciation that. should be applied to property the character of which was fully and clearly disclosed by the report. A contrary conclusion was reached in Wisconsin Box Co. v. Wisconsin Tax Comm. 198 Wis. 439, 224 N. W. 483, where the report did not reveal the manner in which the deduction taken by the taxpayer for depreciation was arrived at. An examination of the record in this case precludes any possibility that the commission was in any manner misled or deceived in reference to the method by which the Taxpayer was reporting its income. Its accounting system, in so far as it deferred profits until the completion of a contract, clearly appears from its reports and the correspondence between the Taxpayer and the commission found in the record. We can see no difference between the situation here presented and that considered in State ex rel. Schuster Realty Co. v. Wis. Tax Comm. 184 Wis. 175, 197 N. W. 585, 199 N. W. 48. In that case the commission sought to apply a different rate of depreciation. In this case it seeks to substitute a different method of accounting. In so far as the increased assessment results from the application of this substituted accounting méthod, the assessment of the commission should be vacated and set aside. This conclusion makes it unnecessary for us to consider whether the commission properly accumulated that portion — 363 — of the additional assessment for the years 1921-1925, inclusive, as an assessment of additional income for the year. 1926, a proceeding to which the Taxpayer strenuously objects. As that portion of the additional income is wiped out, that procedure on the part of the commission becomes immaterial. There remains to be considered one other item entering into the additional assessment to which objection is made by the Taxpayer. It appears that the Taxpayer entered into a contract with one of its stockholders for the purchase of his stock, payment therefor to be made on the instalment plan. During its reports for the years 1925, 1926, and 1927 the Taxpayer deducted from its gross income the amount of the interest paid on the deferred portion of the purchase price of this stock. The Tax Commission disallowed this deduction and included it in the taxable income of the Taxpayer for those years. Sec. 71.03 (2) authorizes deduction for “interest paid during the year in the operation of the business from which its income is derived.” The Tax Commission and the trial court correctly held that this was not interest paid “in the operation of the business from which its income is derived.” Nor is it. a transaction from which any income will ever accrue to the state. The Taxpayer is a corporation. It is taxed upon its income. Income paid to the stockholders in the form of dividends is exempt. It matters not to the state who owns the stock. The purchase of this stock on the part of the corporation was but a mere readjustment of its internal affairs, bearing no relation whatever to its activities giving rise to income. The interest paid by it on the deferred portion of the purchase price of the stock was in no sense of the word paid “in the operation of the business from which its income is derived,” and its deduction was not authorized by the statute. By the Court. — Judgment reversed, and cause remanded with instructions to enter judgment vacating and setting aside that portion of the increased assessment appearing un — 364 — der item 2 of Exhibit C of the record, and affirming the remainder of the assessment.