Opinion
Docket No. 2287-67.
Filed June 12, 1969.
Petitioner, an accrual basis taxpayer, and respondent entered into an agreement settling prior tax liabilities. During its taxable year ending Sept. 30, 1964, petitioner made certain payments pursuant to the terms of the settlement, in an amount less than the total of the compromised taxes and penalties. Held: In accordance with Rev. Rul. 58-239, 1958-1 C.B. 94, the payments are to be applied against the taxes, penalties, and interest, in that order, due for the earliest year, then to taxes, penalties, and interest, in that order, due for each succeeding year, until the payments are absorbed. The portions of the payments thus applied to interest liabilities are deductible for the taxable year 1964 under sec. 163(a), I.R.C. 1954. Held, further, petitioner's accruals of deductible interest are limited to the interest portions of the actual payments made.
Charles A. Poellnitz and James C. Herndon, for the petitioner.
Robert T. Hoffman, for the respondent.
Respondent determined a deficiency in petitioner's income tax for the taxable year ending September 30, 1964, in the amount of $173,180.40. Certain issues have been resolved by stipulation. Also, respondent concedes on brief that petitioner is entitled to an interest deduction for the taxable year 1964, in addition to that allowed in the notice of deficiency, of $540,002.16 paid with respect to income tax deficiencies for the taxable years 1952 through 1956. The sole issue remaining is what amount, if any, is petitioner entitled to deduct as interest under section 163(a) for the taxable year 1964, where the payments made during that year pursuant to a settlement of prior tax liabilities were less than the amount of taxes and penalties, exclusive of interest, covered by the settlement.
The figures for these periods reflect amounts of assessed interest abated on May 2, 1957.
The precise period for which these assessments were made is not indicated in the record.
FINDINGS OF FACT
Robbins Tire Rubber Co., Inc. (hereinafter referred to as petitioner) is an Alabama corporation, having its principal place of business at Tuscumbia, Ala. Petitioner filed its income tax return for the taxable year 1964 with the district director of internal revenue, Birmingham, Ala. (hereinafter district director). For all taxable years pertinent to this proceeding, petitioner maintained its books of account and filed its income tax returns on the accrual basis of accounting.
From the time of its organization in 1940 until the present, petitioner has been in the business of manufacturing rubber automobile tubes for tires, tread rubber, and, from time to time, miscellaneous rubber products.
Upon examination of the income tax and excess profits tax returns filed by petitioner for the taxable years 1942 through 1959, respondent determined deficiencies or overassessments in income, declared-value excess profits, and excess profits taxes and penalties for each taxable year except 1948 and 1949. Petitioner filed petitions with this Court contesting the deficiencies and penalties. These deficiencies, penalties, and overassessments, and the docket numbers in this Court (excluding the taxable years 1952 to 1956), were as follows:
TABLE I Docket No. Taxable year Income tax Excess profits tax Penalty {1942 ....... $17,007.81 $104,511.44 ____________ {1943 ....... (4,265.84) O/A 48,732.66 $24,366.33 {1944 ....... __________ 9,738.07 DVEP 4,869.04 70072 ..... {1944 ....... (6,583.75) O/A 224,223.35 112,111.68 {1945 ....... (11,631.72) O/A 263,380.45 118,801.63 {1946 ....... __________ 150,782.99 63,714.80 {1946 ....... 225,208.87 ____________ 94,287.51 70071 ..... 1947 ....... 166,399.05 ____________ 65,844.72 {1950 ....... 186,062.27 ____________ ____________ {1951 ....... 642,177.67 ____________ ____________ 467-62 .... {1957 ....... 59,288.68 ____________ ____________ {1958 ....... 74,153.91 ____________ ____________ {1959 ....... 34,298.04 ____________ ____________ ------------ ------------ ------------ Total ............. 1,382.114.99 801,368.96 483,995.71 Upon examination of the income tax returns filed by petitioner for the taxable years 1960 through 1963, respondent proposed the following deficiencies and penalty: Penalty, sec. Taxable year Income tax 6655 TABLE II 1960 ................................ $21,486.55 __________ 1961 ................................ 12,203.64 __________ 1962 ................................ 4,961.99 __________ 1963 ................................ 32,341.56 $898.65 ------------ ---------- Total ....................... 70,993.74 898.65Respondent assessed manufacturer's excise taxes, fraud penalties, and interest against petitioner for the periods January 1, 1944, through December 31, 1948, and September 1, 1949, through September 30, 1953, as follows: fn1 fn1 fn2
Not based on assessments.
This table summarizes Tables I, II, and VIII.
This table summarizes Tables III, IV, and V, and takes into account the amounts credited against petitioner's excise tax liabilities on Aug. 26, 1963 (see text following Table VI). The discrepancy between the total for "Accrued Interest" in Table V and in this table, which was stipulated, is unexplained by the record.
All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise noted.
The figures for this period reflect amounts abated on Mar. 13, 1961.
All subsequent references to petitioner's taxable year are to the 12-month period ending on September 30.
Accrued interest is interest which is due by a taxpayer to the Internal Revenue Service from the date of assessment to the date of payment.
By September 30, 1963, petitioner had made the following payments on the assessed excise tax liabilities:
TABLE IV
Taxable year Amount paid
1952 .............. $40,272.30 1953 .............. 120,000.00 1954 .............. 120,000.00 1955 .............. 110,000.00 1956 .............. 560,000.00 1957 .............. 382,000.00 1958 .............. 382,219.80 1959 .............. 676,471.14 1960 .............. 120,000.00 1961 .............. 255,048.17 1962 .............. 131,216.84 1963 .............. 120,000.00 ------------ Total 3,017,228.25
No part of these assessments or payments resulted, at any time, in a deduction for income tax purposes.
Petitioner claimed deductions, for the taxable years 1957 through 1963, for interest accrued fn3 on the assessments of excise tax underpayments as follows:
TABLE V Taxable year Accrued Amount Amount not interest deducted deducted 1955 ........................ $128,430.54 $128,430.54 __________ 1956 ......................... 9,333.34 ___________ $9,333.34 1957 ......................... 269,160.95 124,491.01 144,669.94 1958 ......................... 257,219.40 111,166.63 146,052.77 1959 ......................... 217,012.69 71,208.37 145,804.32 1960 ......................... 203,095.69 53,966.67 149,129.02 1961 ......................... 208,865.41 44,042.23 164,823.18 1962 ......................... 201,959.67 31,863.19 170,096.48 1963 ......................... 194,037.27 24,226.77 169,810.50 Oct. 1, 1963, through Mar. 31, 1964 .............. 94,305.39 ___________ 94,305.39 ----------------------------------------- Total 1,783,420.35 589,395.41 1,194,024.94 No deduction was ever claimed, or reflected on petitioner's books, for any interest accrued on the assessments of penalties. Furthermore, no deduction was ever claimed for assessed interest, except for the taxable year 1956 in which a deduction was claimed in the amount of $157,395.34. However, assessed interest has been entered on petitioner's books of account since the taxable year 1955.These claimed interest deductions were disallowed by respondent on the ground that the assessments were being contested by petitioner. Thus, at no time did petitioner receive a deduction for any interest, accrued or assessed, relative to its excise tax liabilities. Furthermore, at no time was any interest deduction claimed with respect to the income tax liabilities which were under contest. See Table I.
Respondent's disallowance of these deductions was opposed by petitioner, (a) for the taxable years 1957 through 1959 in the petition filed with this Court, see Table I; (b) for the taxable years 1960 and 1961 in protests filed with the district director; and (c) for the taxable years 1962 and 1963 in proposed protests, which were never filed due to the intervening settlement referred to below.
All assessments of excise taxes, and penalties and interest thereon, for the periods after September 30, 1953, were paid by petitioner. However, petitioner and respondent agreed that in order to obtain a judicial determination of the validity of certain excise taxes and penalties asserted by respondent, four taxable excise periods would be selected and made the subjects of suits for refund. Pursuant to this agreement, refund suits were filed in the U.S. District Court for the Northern District of Alabama as follows:
TABLE VI Civil Excise Taxable period action tax Penalty Interest No. November 1947 ................. 1169 ______ $3,565.51 $1,206.99 January 1948 .................. 1175 ______ 3,616.65 940.99 November 1952 ................. 1171 ______ 29,680.47 10,801.80 4th quarter 1958 .............. 1137 $18.01 _________ _________ ----------------------------------------- Total ..................... 18.01 36,862.63 12,949.78These suits were disposed of by a settlement stipulation entered into by the parties on April 4, 1963, pursuant to which petitioner was allowed a total overpayment, including interest, of $43,285.17. This amount was credited by the district director against petitioner's excise tax liabilities on August 26, 1963, as follows: $9 credited against tax, $33,704.42 against penalties, and $9,571.75 against interest. The cases numbered 1169, 1171, and 1175, involving the fraud penalty under section 3612(d)(2), I.R.C. 1939, were settled on the basis of computing the penalties for each period under section 6653(b). Case No. 1137, involving a product known as Decowal, was settled on the basis of crediting petitioner with 50 percent of the amount involved. The stipulation specifically provided that "the basis of settlement of these cases shall not be binding on either party with respect to periods not in suit."
This resulted in asserting the fraud penalty only on the amount of the underpayment and not on the entire tax liability for the taxable period.
On November 1, 1956, petitioner and the district director executed a trust agreement to secure petitioner's unpaid tax liabilities. The agreement provided in pertinent part, as follows:
WHEREAS, the Internal Revenue Service (hereinafter referred to as the Government) is asserting a claim against the Taxpayer for certain excise and income taxes together with statutory interest and penalties; and
* * * * * * *
WHEREAS, it is to the best interest of the Government and of the Taxpayer and of its employees that the business of the Taxpayer be continued so as to preserve assets which will be available to apply against tax liabilities eventually determined and so as to enable Taxpayer to continue its operation and liquidate such tax liabilities.
* * * * * * *
(1) The Taxpayer shall forthwith convey and transfer to Marshall Dugger, as Trustee, for the uses and purposes hereinafter set forth in this agreement, the following:
(a) All of the machinery and equipment owned by Taxpayer, * * *;
(b) All of its real estate, including buildings and houses, * * *;
(c) A certain interest-bearing (6%) promissory note in the principal amount of $1,700,000.00 executed by Florco, Inc., * * * together with collateral security pledged therefore, viz., the entire capital stock of Robbins Floor Products, Inc., * * *
(d) All other assets, * * * but expressly excluding * * * such * * * assets as are necessary to a continuation of the Taxpayer's business without interruption. Nothing in this provision is intended to impair or prevent the usual operation of Taxpayer's business.
* * * * * * *
(3) Taxpayer hereby agrees:
(a) To pay each month on or before the 15th day of such month, beginning in the first month after the execution of this agreement, the sum of $10,000.00 to the District Director of Internal Revenue at Birmingham, Alabama. Said monthly payments shall be applied by the District Director, first, to any assessed excise tax liability of Taxpayer, second, to any asserted income tax liability of Taxpayer, third, to any interest on said excise tax liability, fourth, to interest on any asserted income tax liability, and lastly, to any penalties determined to be due.
(b) To pay promptly and currently all taxes accruing subsequent to the date of this agreement; and to deposit in a special account in a Federal depository all excise taxes on a monthly basis.
(c) To pay to the District Director of Internal Revenue at Birmingham, Alabama, within a period of not more than 120 days after the close of each fiscal year of the Taxpayer, not less than one half of the earnings and profits of the preceding fiscal year in excess of the payments provided for in 3(a), and except that part thereof which may reasonably be needed for purposes of operating capital and reserves as determined by agreement with the District Director of Internal Revenue.
* * * * * * *
(g) To make no expenditure of any kind other than in the usual course of business without first obtaining the written consent of the District Director of Internal Revenue at Birmingham.
(4) The Trustee is hereby authorized and empowered and hereby agrees:
(a) To pay over to the District Director of Internal Revenue at Birmingham, Alabama, within the period of thirty days after receipt thereof, all funds coming into his hands by virtue of this agreement, including, without limitation, the collections of principal and interest on the promissory note of Florco, Inc., in the principal amount of $1,700,000.00 payable to the order of Taxpayer, and described in Paragraph 1(c) hereof. * * *
(b) On failure of Taxpayer to perform any of the obligations imposed under this agreement and at direction of the District Director of Internal Revenue at Birmingham, Alabama, and on notice of not less than sixty days to Taxpayer, during which time Taxpayer shall have the right to cure any default on its part, to sell any or all of the assets and properties held by him. * * *
(c) With the consent and approval of the District Director of Internal Revenue Service at Birmingham, Alabama, first had and obtained, to reconvey the assets and properties held by him to the Taxpayer.
(5) This agreement shall remain in full force and effect until such time as one of the following events occurs: (1) The expiration of ten years from the date of this agreement; (2) the payment of the tax deficiencies, interest and penalties as finally determined by mutual consent of the parties, or by a court of last resort; or (3) by mutual consent of the parties; provided, however, that nothing contained in this paragraph shall affect the right of the District Director of Internal Revenue at Birmingham, Alabama, to cancel this agreement as provided herein.
* * * * * * *
(7) The parties to this instrument agree to execute at any time if called upon by the Director of Internal Revenue waivers of statutory periods of limitation on assessment or collection of any Internal Revenue taxes. * * *
The note of Florco, Inc. (hereinafter Florco), referred to in paragraphs (1)(c) and (4)(a) of the trust agreement, was given in connection with the sale by petitioner to Florco, on April 24, 1956, of all the stock of petitioner's subsidiary, Robbins Floor Products, Inc. (hereinafter Floor Products). The note was to be paid in 10 annual installments of $170,000 each.
In the years following execution of the trust agreement petitioner submitted numerous offers to compromise its unpaid tax liabilities. Agreement between the parties was finally reached in a conference held in Cleveland, Ohio, on December 19 and 20, 1963. Among the principles agreed to at this meeting were the following:
(1) All previous offers would be withdrawn, as requested by respondent's representatives.
(2) Two new "offers" would be submitted. The first was to cover petitioner's excise tax liabilities for the periods January 1944 through September 1963, inclusive, although there were no unpaid assessments for periods after September 30, 1953. The second offer was to cover income and excess profits taxes, penalties, and interest for the taxable years 1942 through 1951 and 1957 through 1963.
(3) A collateral agreement would be executed.
(4) The trust agreement of November 1, 1956, would be amended.
(5) Contingent upon acceptance of the submitted offers, the unpaid income tax, and interest thereon, for the taxable years 1952 through 1956, would be paid in full and thus not be included in the income tax offer. This was decided because during these years petitioner had filed consolidated income tax returns with Floor Products; Floor Products was thus jointly liable for these years; and Floor Products was financially able to pay the proposed tax liability.
The offers in compromise, dated September 30, 1963, and filed March 19, 1964, were submitted on respondent's Form 656. The offer with respect to income and excess profits tax liabilities contained the following:
1. This offer is submitted by the undersigned to compromise a liability resulting from alleged violation(s) of law or failure to pay an internal revenue liability as follows: Income taxes, excess-profit taxes, interest, fraud penalties, and additions thereto. For the taxable years ended 9-30-42 through 9-30-51, inclusive, and 9-30-57 through 9-30-63, inclusive.
2. The total sum of $517,782.63 paid in full or payable on the deferred payment basis as follows: $27,500.00 now on deposit, and balance in installments of not less than $5,500.00 per month, commencing on March 15, 1964, and on the 15th day of each month thereafter until March 15, 1970, and the balance, if any, to be paid on the 31st day of March, 1970 (See Paragraph 5.) together with interest at the rate of 6 percent per annum on the deferred payments, if any, from the date the offer is accepted until the respective payments are made in full, is hereby tendered voluntarily with the request that it be accepted in compromise of the above described liability (plus any accrued interest on the liability covered by this offer) of the taxpayer aforesaid.
3. In making this offer, and as a part consideration thereof, the proponent agrees (a) that all payments and other credits heretofore made to the account(s) for the period(s) covered by this offer shall be retained by the United States; and (b) that any and all amounts of money to which the proponent may be entitled under the internal revenue laws, due through overpayments of any tax or other liability, including interest and penalties, made for periods ending prior to or during the calendar year in which this offer is accepted, as are not in excess of the difference between the liability sought to be compromised and the amount herein offered, shall also be retained by the United States. Any such refund received after the filing of this offer will be returned immediately to the office of the District Director.
4. It is further agreed that upon notice to the proponent of the acceptance of this offer in compromise of the liability aforesaid, the proponent shall have no right to contest in court or otherwise the amount of the liability sought to be compromised; and that in the event this offer is a deferred payment offer and there is a default in payment of any installment of principal or interest due under the terms of the offer, the Commissioner of Internal Revenue (or his delegate), at his option, (a) may proceed immediately by suit to collect the entire unpaid balance of the offer, or (b) may proceed immediately by suit to collect as liquidated damages an amount equal to the liability sought to be compromised, minus any deposits already received under the terms of the offer in compromise, with interest on the unpaid balance at the rate of 6 percent per annum from the date of default, or (c) may disregard the amount of such offer and apply all amounts previously deposited thereunder against the amount of the liability sought to be compromised and may, without further notice of any kind, assess and/or collect by levy or suit the balance of such liability, the right of appeal to the Tax Court of the United States and the restrictions against assessment and/or collection being hereby waived.
5. The following facts and reasons are submitted as grounds for acceptance of this offer: Inability to pay. This is one of two offers submitted by the undersigned and there is also submitted a related offer of Poncet Davis, Sr. If any of said 3 offers are rejected, this offer is withdrawn and is null and void.
6. The undersigned proponent waives the benefit of any statute of limitations applicable to the assessment and/or collection of the liability sought to be compromised, and agrees to the suspension of the running of the statutory period of limitations on assessment and/or collection for the period during which this offer is pending, or the period during which any installment remains unpaid, and for 1 year thereafter.
7. It is understood that this offer will be considered and acted upon in due course and that it does not afford relief from the liability sought to be compromised unless and until it is actually accepted in writing by the Commissioner or his duly authorized representative, and the terms of the offer have been fully complied with.
The offer submitted to compromise the excise tax liabilities provided in paragraphs 1 and 2 as follows:
1. This offer is submitted by the undersigned to compromise a liability resulting from alleged violation(s) of law or failure to pay an internal revenue liability as follows: Manufacturers' excise taxes, penalties and interest, and additions thereto [b]eginning January 1944 and each period thereafter to and including September 1963.
2. The total sum of $423,640.34 paid in full or payable on the deferred payment basis is as follows: $22,500.00 now on deposit, and balance in installments of not less than $4,500.00 per month, commencing on March 15, 1964, and on the 15th day of each month thereafter until March 15, 1970, and the balance, if any, to be paid on the 31 day of March, 1970 * * *
The remaining provisions of this offer were substantially identical to those contained in the income tax offer.
In addition to the two offers in compromise, and as "additional consideration for the acceptance of" them, petitioner executed a collateral agreement. Under the terms of this agreement petitioner obligated itself to pay to the district director, for each of the taxable years 1964 through 1973, (a) nothing with respect to the first $25,000 of annual income; (b) 30 percent of annual income in excess of $25,000 and not in excess of $50,000; and (c) 50 percent of annual income in excess of $50,000. The term "annual income" was defined in the agreement as "taxable income before net operating loss deduction and special deductions * * * plus all non-taxable income minus (a) the Federal income tax due for the year in question and paid, and (b) any payment made on the offers in compromise, for the year in which such payment is made." It was also agreed that annual income would not include the amount of any prepayment of the note due petitioner from Florco which was to be credited to the offers, but that such prepayment would be allocated to annual income for the year in which payment was due under the terms of the note. After setting forth certain limitations on net operating loss carryovers and carrybacks, the agreement further provided:
6. That the aggregate amount paid in accordance with the terms of the offers and the additional amounts paid under the terms of this agreement shall not exceed the liability covered by the offers in compromise plus accrued interest that would become due in the absence of the compromise.
7. That upon notice to the taxpayer of the acceptance of the offers in compromise of the liabilities aforesaid, the taxpayer shall have no right, in the event of default in payment of any installment of principal or interest due under the terms of the offers and this agreement, or in the event any other provision of this agreement is not carried out in accordance with its terms, to contest in court or otherwise the amount of the liability sought to be compromised; and that in the event of such default or noncompliance, the Commissioner of Internal Revenue or his delegate at his option, (a) may proceed immediately by suit to collect the entire unpaid balance of the offers and this agreement, or (b) may proceed immediately by suit to collect as liquidated damages an amount equal to the tax liability sought to be compromised minus any payments already received under the terms of the offer in compromise and this agreement, with interest at the rate of 6% per annum from the date of default or (c) may disregard the amount of such offers and this agreement, and apply all amounts previously paid thereunder against the amount of the liabilities sought to be compromised and may, without further notice of any kind, assess and/or collect by levy or suit (the restrictions against assessment and/or collection being specifically waived) the balance of such liability.
8. That the taxpayer waives the benefit of any statute of limitations applicable to the assessment and/or collection of the liability sought to be compromised, and agrees to the suspension of the running of the statutory period of limitations on assessment and/or collection for the period during which the offers and this agreement are pending or the period during which any installment under the offers and/or this agreement remains unpaid or any provision of this agreement is not carried out in accordance with its terms, and for one year thereafter.
* * * * * * *
11. That if either of the two offers submitted for Robbins Tire Rubber Company or the related offer of Poncet Davis, Sr., are rejected, this agreement is withdrawn and rendered null and void. This agreement shall be of no force or effect unless all of the said offers in compromise are accepted.
As part of the settlement between the parties, and "to implement the * * * offers in compromise," the trust agreement of November 1, 1956, was amended on March 17, 1964. The amendment related primarily to the manner in which the offers in compromise were to be paid. It provided that the payment of the balance due petitioner on the Florco note, $510,000, and the monthly payments of $10,000, described in paragraph (3)(a) of the original trust agreement, would be applied to the amounts due under the offers in compromise, 45 percent of each payment to the excise tax offer and 55 percent to the income tax offer. In addition, the amendment provided, inter alia: That the trust agreement would remain in force until petitioner had paid the offers in compromise in full, at which time it would terminate; that the property subject to the original trust agreement would be security for the performance by petitioner of the offers in compromise; that in the event of default, the district director would have alternative remedies to proceed under the terms of the offer or under the terms of the trust agreement; that paragraphs (3)(c) and (5) of the original trust agreement, quoted above, were void; and that the amended trust agreement, together with the offers in compromise and the collateral agreement, "shall constitute the entire agreement between the parties."
In connection with the offers in compromise and the collateral agreement, and conditioned upon their acceptance, the petitions filed with this Court, see Table I, were disposed of by stipulations filed on or about April 16, 1964, whereby petitioner agreed to the assessment of the total income and excess profits tax deficiencies and penalties set forth in the notices of deficiency for the respective taxable years; petitioner also agreed to assessment of the income tax deficiencies and penalties proposed for the taxable years 1960 through 1963. Also related to the offers, "as additional consideration," and conditioned upon their acceptance was an agreement by petitioner, dated March 12, 1964, to withdraw all claims for refund which had been filed, or which could have been filed, with respect to any of the taxable years covered by the offers in compromise. The following specific claims relating to income tax were withdrawn:
TABLE VII
Period Amount of claim
10/1/50 to 9/30/51 ........... $129,821.44 10/1/55 to 9/30/56 ........... 361,279.63 10/1/56 to 9/30/57 ........... 159,997.98 10/1/57 to 9/30/58 ........... 198,536.00 10/1/58 to 9/30/59 ........... 267.754.69 10/1/59 to 9/30/60 ........... 59,770.75 10/1/60 to 9/30/61 ........... 32,329.39 ------------ Total ..................... 1,209,489.88
On or about April 22, 1964, respondent, through the district director, assessed the tax and penalties and credited the overassessments summarized in Table I, and assessed interest as follows:
TABLE VIII
Taxable year Interest
1942 .................. $155,704.44 1943 .................. 54,455.57 1944 .................. 264,270.53 1945 .................. 277,579.58 1946 .................. 384,524.74 1947 .................. 159,008.25 1950 .................. 149,063.91 1951 .................. 475,950.42 1957 .................. 22,597.92 1958 .................. 23,814.57 1959 .................. 8,956.95 1960 .................. 4,260.52 1961 .................. 1,687.61 1962 .................. 385.20 1963 .................. 570.18 ----------- Total .......... 1,982,830.39
Pursuant to an offer accepted by respondent on January 27, 1961, Florco paid $246,450 to the district director on April 24, 1964, to compromise an asserted income tax liability as transferee of petitioner's assets. Florco made this payment even though, under the terms of the offer, payments were not due until 1967, and it had been agreed that:
If all of the tax liabilities of [petitioner] as of April 24, 1956, as finally determined, shall be satisfied before Florco shall have completed its scheduled payments with respect to such transferee assessment * * * no further payment need be made by Florco * * * and such assessment shall be abated and cancelled.
By letter dated May 1, 1964, respondent accepted the overall settlement offered by petitioner. As of that date, petitioner's unpaid liabilities for income, excess profits, and declared value excess profits taxes, penalties, and interest (excluding the taxable years 1952 through 1956) were as follows:fn1 Percent to Unpaid amount total
TABLE IX Taxes ............................... $2,254,477.69 47.742 Penalties ........................... 484,894.36 10.269 Assessed interest ................... 1,982,830.39 41.989 -------------- ---------- Total ............................ 4,722,202.44 100.000 Petitioner's unpaid liabilities for excise taxes, penalties, and interest as of the date of the acceptance of the excise tax offer in compromise were as follows:fn1 Unpaid amount Percent to total
TABLE X Excise taxes ...................... $407,201.98 7.343 Penalties ......................... 2,585,947.32 46.634 Assessed interest .... $897,030.96 16.177 Accrued interest .... 1,654,989.81 29.846 ------------ ------ Total interest .................... 2,552,020.77 46.023 ------------ ------- Total ......................... 5,545,170.07 100.000 Pursuant to the terms of the settlement, petitioner made the following payments during the taxable year 1964 under the offers in compromise: Full amount of Type of offer offer Amount paid TABLE XI Income tax ........................ $517,782.63 $362,226.39 Excise tax ........................ 423,640.34 296,367.05 ----------- ----------- Total .......................... 941,422.97 658,593.44 On February 3, 1965, petitioner paid $15.88 pursuant to the collateral agreement, for the taxable year 1964. This amount was computed as follows (all figures are for the taxable year 1964): TABLE XII Taxable income .......................................... $556,453.27 Less: Income tax due ........................ $169,035.03 Payments on the offer ..... $658,593.44 Deduct: Prepayment of Florco note ............. 340,000.00 318,593.44 ---------- Other .................................. 43,771.86 531,400.33 ----------- ---------- Total annual income ........................... 25,052.94 Payment due: Nothing with respect to the first $25,000 of annual income 30 percent of $52.94 .............................. 15.88 Total amount due under collateral agreement ..................................... 15.88On its income tax return for the taxable year 1964, petitioner deducted $300,069 as "the interest portion of payments made by the taxpayer during the fiscal year on offers in compromise." A statement attached to petitioner's return explained the claimed deduction as follows:
Taxpayer considers that each payment under the offers constitutes interest in the proportion that the total interest liability compromised bears to the total liability for taxes, penalties and interest which was compromised. The amount of interest deducted on this basis was computed as follows: Amount paid on offer in Percent which Amount which compromise is interest is interest
Income taxes ......... $362,226.39 41.990 $152,098.86 Excise taxes ......... 296,367.05 49.928 147,970.14 ----------- ----------- Total ............. 658,593.44 300,069.00 Respondent disallowed this entire amount. In its petition, petitioner claims, in addition to the above payments, interest deductions for the taxable year 1964 of $540,002.16, as the interest paid with respect to the income tax liabilities for the taxable years 1952 through 1956, and of $6.96, as the interest portion of the amount paid pursuant to the collateral agreement; in the alternative petitioner claims deductions for accrued interest.OPINION
In 1964 petitioner and respondent entered into a comprehensive agreement to settle certain of petitioner's liabilities for taxes, penalties, and interest for prior years. During the taxable year 1964 petitioner made payments pursuant to two offers in compromise and a collateral agreement, in a sum less than the aggregate amount of the compromised taxes and penalties. The issue is whether, as a result of the settlement, petitioner is entitled to any deduction under section 163(a) for the taxable year 1964 for interest paid or accrued.
SEC. 163. INTEREST.
(a) GENERAL RULE. — There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness.
Petitioner contends that each payment constituted interest "in the proportion that the total interest liability compromised bears to the total liability for taxes, penalties and interest which was compromised." Thus petitioner would have us conclude that it is entitled to a deduction for the taxable year 1964 for interest paid under the offers in the amount of $288,492.25, and for interest paid under the collateral agreement in the amount of $6.96. Alternatively, petitioner argues that since the compromised liabilities were being contested when the settlement was reached, the interest portion thereof became fixed and determined at that time, not before; and that consequently, it is entitled to accrue for the taxable year 1964 a deduction either (1) of $412,383.74, as the interest portion of the total amount of the offers; or (2) of $4,534,851.16, representing the aggregate amount of the interest liabilities compromised.
This amount is computed as follows:
Amount paid Percent, Amount of Type of offer on offer interest interest factor
Income tax ........ $362,226.39 41.989 $152,095.24 Excise tax ........ 296,367.05 46.023 136,397.01 ----------- ----------- Total ........... 658,593.44 288,492.25
This figure is computed as follows:
Amount of Percent, Amount of Type of offer offer interest interest factor
Income tax ......... $517,782.63 41.989 $217,411.75 Excise tax ......... 423,640.34 46.023 194,971.99 ------------ ----------- Total ............ 941,422.97 412,383.74
Respondent maintains that no portion of the payments constituted interest, either paid or accrued, because the payments were less in amount than the compromised taxes and penalties, exclusive of interest. The foundation of respondent's position is I.T. 3852, 1947-1 C.B. 15, which states, in part, the following:
In the case under consideration deficiencies in Federal income tax, together with penalties and interest thereon, were determined to be due. Thereafter, the taxpayer submitted an offer in compromise of his tax liability, penalties, and interest in a lump sum less than the principal amount of the deficiencies, which offer was accepted by the Government. The taxpayer desires to apportion a part of the total payment to interest and deduct it in determining his net income.
* * * * * * *
It is the position of the Bureau, however, that the acceptance of a lump sum in compromise of Federal income tax, penalties, and interest does not result in payment of income tax, penalties, or interest, but is in lieu of liability therefore. Accordingly, in the instant case, no part of the amount accepted by the Government from the taxpayer in compromise of the proposed income tax deficiencies, plus penalties and interest thereon, may be deducted as interest under section 23(b) of the Internal Revenue Code, supra. (Cf. Max Thomas Davis et al. v. Commissioner, 46 B.T.A., 663, acquiescence, C.B. 1942-1, 4, which is clearly distinguishable on the facts involved therein.) [Emphasis added.]
Also see Rev. Rul. 58-239, 1958-1 C.B. 94. The reasoning of I.T. 3852 has been applied in William Justin Petit, 8 T.C. 228, 236 (1947), and William C. Atwater Co. v. Bowers, 5 F. Supp. 916 (S.D.N.Y. 1934), reversed on other issues 74 F.2d 253 (C.A. 2, 1934). Cf. Eagle Asbestos Packing Co. v. United States, 172 Ct. Cl. 304, 348 F.2d 528, 532 (1965).
It is obvious that in order for the principles stated in I.T. 3852 to be applicable there must first be a "lump sum" compromise. But the settlement here involved more than a "lump sum" payment. In addition to the conditions and restrictions contained in the two offers in compromise, the settlement included:
(1) Execution of a collateral agreement under which petitioner obligated itself for the 10 succeeding taxable years to pay certain specified percentages of its "annual income," waived the right to contest the compromised liabilities, waived the benefit of net operating loss carryovers for prior years and net operating loss carryovers and carrybacks for the 10 years covered by the agreement, waived the benefit of all statutes of limitations on the assessment and collection of the compromised liabilities, agreed to adjustments in the basis of its assets, and made other concessions;
(2) Amendment of the trust agreement of November 1, 1956;
(3) Payment in full of the income tax liabilities for the taxable years 1952 through 1956, effected partially by reallocation of a portion of petitioner's prior payments which had been credited against its excise tax liabilities;
(4) Withdrawal by petitioner of all claims for refund, amounting to more than $1,200,000, and waiver of the right to file further claims for refund for the years covered by the offers in compromise;
(5) Entry of stipulated decisions in proceedings then pending before this Court (see Table I), whereby petitioner agreed to assessment of all income tax liabilities, including penalties and interest, for the taxable years 1942 through 1963; and
(6) Payment by Florco of $246,450 to compromise its income tax liability as transferee of petitioner's assets.
All of these transactions were conditioned upon acceptance by respondent of petitioner's offers, and were significant ingredients of the settlement. This multifaceted agreement cannot be equated with the "lump sum" compromise described in I.T. 3852, see J. Harold Finen, 41 T.C. 557, 561 fn. 2 (1964), acq. 1964-2 C.B. 5, and that ruling, therefore, is inapplicable to the present case.
Respondent, however, has other arrows in his quiver. He contends that acceptance of the offers extinguished the compromised liabilities for taxes, penalties, and interest — which thereupon lost their identity as such — and substituted therefore a new contractual liability, Big Diamond Mills Co. v. United States, 51 F.2d 721, 725 (C.A. 8, 1931); and that payments in satisfaction of this contractual obligation cannot in any part be said to include interest. But this Court rejected a similar contention in J. Harold Finen, supra at 560, 561, where a collateral agreement similar to the present one was involved, stating:
Petitioners' liability for the unpaid * * * deficiencies in tax, penalties, and interest was not extinguished by the payment * * * [under the offer in compromise]. The Commissioner's argument to the contrary appears to be based on the erroneous premise that the compromise agreement was confined to the terms of the offer in compromise submitted on standard Treasury Form 656-C. But the terms of the compromise agreement accepted by the Commissioner were contained in two documents, the "Offer in Compromise" on Form 656-C and the collateral agreement. * * *
* * * * * * *
Plainly, petitioners were not released from their unpaid liability for tax, penalties, and interest by the payment * * *. It was the intention of the parties that petitioners would continue to make payments in satisfaction of that liability pursuant to the terms of the collateral agreement. * * *
Thus, respondent's argument that the amendment of par. (3)(a) of the trust agreement of Nov. 1, 1956 — deleting the specific provision for the application of the monthly payments to taxes, interest, and penalty in that order — " implies that the parties understood the payments on the offers were payments on substituted liabilities and not the payment of tax, penalty or interest," is without merit. Also see the discussion below of Rev. Rul. 58-239, 1958-1 C.B. 94.
Also see United States v. Feinberg, 372 F.2d 352, 356 (C.A. 3, 1967); Lustig v. United States, 134 Ct. Cl. 351, 138 F. Supp. 870, 873 (1956). In addition, acceptance of respondent's "substituted contractual obligation" theory would render meaningless many of the provisions of the offers in compromise and the collateral agreement. See, e.g., paragraphs 3(b), 4, and 6 of the offers, and paragraphs 6, 7, and 8 of the collateral agreement, all quoted in our findings.
For petitioner to prevail, however, it must prove that "the amount of interest is ascertainable from the agreement or the circumstances surrounding the agreement." Id.; J. Harold Finen, supra; Max Thomas Davis, 46 B.T.A. 663 (1942), acq. 1942-1 C.B. 4. In addition, since petitioner is an accrual basis taxpayer, it has the further burden of showing what part, if any, of the ascertainable interest accrued in its taxable year 1964. We believe petitioner has made the requisite showing for an interest deduction to be computed in the manner discussed below.
In reaching this conclusion we begin with the principle that a compromise is a contract and thus is a proper subject of judicial interpretation as to its meaning, in the light of the language used and the circumstances surrounding its execution. Colorado Milling Elevator Co. v. Howbert, 57 F.2d 769, 771 (C.A. 10, 1932); Big Diamond Mills Co. v. United States, supra at 724; Max Thomas Davis, supra at 671.
None of the various documents embodying the overall contract of settlement refers specifically to the manner in which petitioner's payments are to be credited against its various liabilities. Paragraph (3)(a) of the original trust agreement had provided that the monthly payments of $10,000 "shall be applied by the District Director, first, to any assessed excise tax liability of Taxpayer, second, to any asserted income tax liability of Taxpayer, third, to any interest on said excise tax liability, fourth, to interest on any asserted income tax liability, and lastly, to any penalties determined to be due." However, the amended trust agreement eliminated this method of applying the monthly payments, and provided only that the $10,000 monthly payments be continued and that 45 percent of such payments be applied by the district director "to the payment of the excise tax offer * * * and the remaining fifty five per cent (55%) to the income tax offer * * * until said offers are paid."
The offers in compromise and the collateral agreement provided that, in the event of default by petitioner in the payment of any installment of principal or interest due thereunder, respondent could: (1) Proceed immediately by suit to collect the entire balance due under the offers and the collateral agreement; (2) proceed immediately by suit to collect as liquidated damages an amount equal to "the liability sought to be compromised" minus any payments already received under the offers and the collateral agreement, together with interest; or (3) disregard the amounts of the offers and the collateral agreement and apply all amounts paid thereunder against the amount of the liability sought to be compromised and "assess and/or collect by levy or suit * * * the balance of such liability." Furthermore, paragraph 6 of the collateral agreement provided "That the aggregate amount paid in accordance with the terms of the offers and the additional amounts paid under the terms of this agreement shall not exceed the liability covered by the offers in compromise plus accrued interest that would become due in the absence of the compromise."
The validity of agreements containing almost identical terms has been sustained in United States v. Lane, 303 F.2d 1, 4 (C.A. 5, 1962), and United States v. Feinberg, 372 F.2d 352, 358 (C.A. 3, 1967).
These provisions clearly contemplate that payments made under the offers and the collateral agreement are to be credited against the compromised taxes, penalties, and interest in accordance with some specific procedure; otherwise, there would be no way of computing the respective amounts of taxes, penalties, and interest remaining due in case of default by petitioner and respondent's exercise of either the second or the third remedies above, or of ascertaining the maximum amounts payable under the collateral agreement, i.e., the compromised liabilities plus the "accrued interest that would become due in the absence of the compromise." Some method of applying the credits was obviously contemplated because the statutory rules prescribing interest on taxes, penalties, and interest are each distinctive.
SEC. 6601. INTEREST ON UNDERPAYMENT, NONPAYMENT, OR EXTENSIONS OF TIME FOR PAYMENT OF TAX.
(a) GENERAL RULE. — If any amount of tax imposed by this title (whether required to be shown on a return, or to be paid by stamp or by some other method) is not paid on or before the last date prescribed for payment, interest on such amount at the rate of 6 percent per annum shall be paid for the period from such last date to the date paid.
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(f) APPLICABLE RULES. — Except as otherwise provided in this title —
(1) INTEREST TREATED AS TAX. — Interest prescribed under this section on any tax shall be paid upon notice and demand, and shall be assessed, collected, and paid in the same manner as taxes. Any reference in this title (except subchapter B of chapter 63, relating to deficiency procedures) to any tax imposed by this title shall be deemed also to refer to interest imposed by this section on such tax.
(2) NO INTEREST ON INTEREST. — No interest under this section shall be imposed on the interest provided by this section.
(3) INTEREST ON PENALTIES, ADDITIONAL AMOUNTS, OR ADDITIONS TO THE TAX. — Interest shall be imposed under subsection (a) in respect of any assessable penalty, additional amount, or addition to the tax only if such assessable penalty, additional amount, or addition to the tax is not paid within 10 days from the date of notice and demand therefore, and in such case interest shall be imposed only for the period from the date of the notice and demand to the date of payment.
Petitioner insists that an allocation should be made in proportion to the amounts of taxes, penalties, and interest which were compromised, computed as of the date of the settlement. But nothing in the agreements supports such an allocation. Consequently, we must look elsewhere to determine the method of applying petitioner's payments against its compromised liabilities.
The procedure employed by the Internal Revenue Service in cases where a taxpayer tenders partial payments on his tax liabilities and gives no instructions as to how such payments shall be applied, is stated in Rev. Rul. 58-239, 1958-1 C.B. 94, 95, as follows:
Where an assessment is made for one or more years and there are no specific instructions as to the application of the partial payment tendered by the taxpayer, the amount of the payment will be applied by the District Director first to tax, penalty and interest, in that order, for the earliest year, then to tax, penalty and interest, in that order, for the next succeeding year, until the payment is absorbed. * * *
Amounts tendered, in partial payment of deficiencies mutually agreed to as to the amount of liability but unassessed at the time of the tender, for one or more years, without instructions from the taxpayer, as to the application of the payment, will be applied by the District Director first to tax, penalty and interest, in that order, due for the earliest year, the interest to be computed under the applicable provisions of law, then to tax, penalty and interest, in that order, for the next succeeding year until the payment is absorbed. * * * The portion of the payment applied to interest for any year will be deductible in computing taxable income for the year in which the partial payment is made. * * *
Although this ruling is directed to the right of a cash basis taxpayer to deduct portions of payments made against prior tax liabilities, we think it quite clear that the procedure established therein for crediting partial payments would be the same for an accrual basis taxpayer.
In the circumstances of this case it is reasonable to construe the settlement documents, as a whole, to provide for the application of petitioner's payments in accordance with the procedure prescribed by Rev. Rul. 58-239. Specific crediting procedures had been set forth in paragraph (3)(a) of the November 1, 1956, trust agreement; in the period between the date of that agreement and the negotiation of the final settlement, Rev. Rul. 58-239 was issued and thereby became the established procedure of the Internal Revenue Service. As a part of the settlement the trust agreement was amended to eliminate paragraph (3)(a). The officials of the Service who negotiated the settlement were presumably aware of the procedure set forth in Rev. Rul. 58-239, and they obviously dictated many of the terms of the settlement with the distressed taxpayer. Representatives of petitioner, who had been in communication with the Service almost continuously over a period of years in a protracted effort to adjust petitioner's tax liabilities, were also likely to have been aware of that procedure. Finally, the compromise offers were submitted on the standard Form 656 (rev. 7-57), prescribed by the Service for general use in submitting offers in compromise. Rev. Proc. 57-41, 1957-2 C.B. 1119; sec. 601.203 (b), Proced. Rules. A reasonable inference is that the crediting of payments required by the agreement was to be made in accordance with the standard practice of the Service.
In James F. Keith, 35 T.C. 1130, 1139 fn. 9 (1961), commenting on Rev. Rul. 58-239, this Court stated: "We know of no published procedure relative to this matter prior to 1958, and it is our understanding that the application was left up to the individual district director." Cf. John A. Amos, 47 T.C. 65, 69 fn. 4 (1966).
Respondent places great reliance on J. Harold Finen, 41 T.C. 557 (1964). The negotiations and agreement compromising the tax liabilities of the taxpayer in Finen took place prior to the issuance of Rev. Rul. 58-239. Consequently, no specific crediting procedure could have been mutually contemplated by the parties therein. See fn. 18, supra. Furthermore, the opinion in Finen was not required to reach the question presented here because of the taxpayer's abandonment of his claims for interest deductions in the earlier years.
In determining the amount of the payments deductible as interest by petitioner in its taxable year 1964, we turn to the basic rule applicable under the accrual method of accounting — "an expense is deductible for the taxable year in which all the events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy." Sec. 1.461-1 (a)(2), Income Tax Regs.; Dixie Pine Co. v. Commissioner, 320 U.S. 516 (1944); Lehigh Valley Railroad Co., 12 T.C. 977, 995 (1949). As applied to the facts of this case, this rule requires that petitioner's accruals of deductible interest be measured by the payments it made.
Since the compromised liabilities, with one exception noted in the footnote below, were being contested when the settlement agreement was reached, see sec. 1.461-2 (b)(2), Income Tax Regs.; Dixie Pine Co. v. Commissioner, supra; Gunderson Bros. Engineering Corp., 16 T.C. 118, 126 (1951), we agree with petitioner that they could not have accrued prior thereto. Lehigh Valley Railroad Co., supra at 997. However, we cannot agree that the interest portion of those liabilities or of the full amount of the offers became fixed and determined during the taxable year 1964, because the settlement agreement did not determine "with reasonable accuracy" the amount of the interest liability which would be discharged by petitioner.
Petitioner contested all its liabilities for income and excess profits taxes, and penalties and interest thereon, and its liabilities for excise taxes, penalties, and interest, with the exception of the excise taxes assessed for Aug. 1, 1952, to Sept. 30, 1953, and the amounts assessed on Nov. 27, 1959, and Jan. 12, 1961. See Tables I and III.
Sec. 1.461-2 Timing of deductions in certain cases where asserted liabilities are contested.
(b) Contest of asserted liability. — * * *
(2) Definition of the term "contest." Any contest which would prevent accrual of a liability under section 461 (a) shall be considered to be a contest in determining whether the taxpayer satisfies paragraph (a)(1)(i) of this section. A contest arises when there is a bona fide dispute as to the proper evaluation of the law or the facts necessary to determine the existence or correctness of the amount of an asserted liability. It is not necessary to institute suit in a court of law in order to contest an asserted liability. An affirmative act denying the validity or accuracy, or both, of an asserted liability to the person who is asserting such liability, such as including a written protest with payment of the asserted liability, is sufficient to commence a contest. Thus, lodging a protest in accordance with local law is sufficient to contest an asserted liability for taxes. It is not necessary that the affirmative act denying the validity or accuracy, or both, of an asserted liability be in writing if, upon examination of all the facts and circumstances, it can be established to the satisfaction of the Commissioner that a liability has been asserted and contested.
While petitioner agreed that upon notice of acceptance of the offers in compromise it should "have no right to contest in court or otherwise the amount of the liability sought to be compromised," see United States v. Feinberg, supra at 358-359, and United States v. Lane, 303 F.2d 1, 4 (C.A. 5, 1962), thus fixing that amount as its maximum liability, the amount it would ultimately pay was rendered uncertain by the installment provisions of the compromise offers and the annual payments under the collateral agreement. Only its minimum liability, i.e., the amount paid, was fixed by the close of the taxable year 1964. We recognize, of course, that the fact of payment normally does not control the accruability of an otherwise accruable expense. United States v. Anderson, 269 U.S. 422 (1926). But even if the total installments under the compromise offers are treated as a fixed obligation, the amounts attributable to discharge of interest liabilities could not be determined until the payments were actually tendered and credited to the tax, penalty, and interest in each year, thereby fixing the amount of interest accrued on the discharged amounts. Stated another way, since interest on the unpaid liabilities continues to accrue until the date of payment, sections 6601 (a) and (f)(3), the amount of interest which is discharged by application of the procedure of Rev. Rul. 58-239, cannot be "determined with reasonable accuracy" until actual payment is made. In these circumstances petitioner's interest deduction for the taxable year 1964 is limited to the interest portion of the payments it made during that year.
In summary, we hold that the payments made under the November 1, 1956, trust agreement prior to its amendment should be credited in accordance with paragraph (3)(a) thereof, subject, however, to the reallocation of such payments to discharge petitioner's liability for income tax, penalties, and interest for the taxable years 1952 through 1956. As conceded by respondent, petitioner is entitled to a deduction of $540,002.16 for interest paid in the taxable year 1964 on such liabilities. All payments made pursuant to the offers in compromise and the collateral agreement should be credited, when paid, in accordance with Rev. Rul. 58-239 against the balance remaining due, 45 percent to be applied to excise taxes, penalties, and interest, and 55 percent to income and excess profits taxes, penalties, and interest. The amounts thus applied to interest liabilities of prior years are deductible by petitioner under section 163(a) for the taxable year 1964.
Decision will be entered under Rule 50 .