Opinion
Docket Nos. 13837 13838 13848.
1948-08-31
RUBEN SIMON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.MEYER SIMON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.MORRIS SIMON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
B. Dave Bushaw, Esq., for the petitioners. Philip J. Wolf, Esq., for the respondent.
Upon the facts, held, that the execution by partners of a conditional agreement, made subsequent to the close of the partnership's fiscal year, to refund a portion of the partnership income received during such fiscal year does not retroactively reduce the distributed income of the partnership for that year. B. Dave Bushaw, Esq., for the petitioners. Philip J. Wolf, Esq., for the respondent.
These proceedings, which were consolidated for hearing, involve the income and victory tax liability of the petitioners for the taxable year ended December 31, 1943, in the respective amounts of $5,974,28 for Ruben Simon, $6639.81 for Meyer Simon, and $6,562.56 for Morris Simon. Such deficiencies resulted from the Commissioner's action in increasing the income of each petitioner for the taxable year ended December 311943by an amount representing his distributive share of the difference between a rental income of the partnership of Simon Brothers in its fiscal year ended October 31, 1943, based on 6 per cent of the gross sales of the partnership's lessee and a rental income based on 4 3/4 per cent of such sales.
Each of the petitioners also assigned as error the determination of the Commissioner concerning an analogous question with respect to the taxable year ended December 31, 1942, but this issue was abandoned at the hearing.
The Federal income and victory tax returns of the petitioners for the year 1943 were filed with the collector of internal revenue for the district of Michigan, at Detroit.
Such of the facts as are stipulated are so found.
FINDINGS OF FACT.
The petitioner are residents of Pontiac, Michigan. They are brothers and are equal partners in the partnership of Simon Brothers (hereinafter referred to as the partnership), which they formed on November 1, 1941. At the time of its formation the principal asset of the partnership was a leasehold expiring June 30, 2032, on certain premises located in Pontiac, Michigan. On November 1, 1941, petitioners also organized the Simms' Cut Rate Stores, Inc., a Michigan corporation (hereinafter referred to as the corporation). Petitioners were the only officers and directors of his corporation and owned its entire capital stock in equal shares. On November 5, 1941, the partnership leased the Pontiac premises to the corporation for a period of 10 years. The latter opened a department store there, and under the terms of the lease it paid a rental to the partnership based on 6 per cent of its gross sales. The lease provided for the payment of rent to the partnership in quarterly installments, such installments to be paid on the 15th of the month following the expiration of each 3-month period of the lease.
The corporation kept its books and filed its returns on the accrual basis of accounting and on a fiscal year basis beginning November 1 and ending October 31. The partnership kept its books and filed its return on the cash receipts and disbursements basis and on a fiscal year basis beginning November 1 and ending October 31. The petitioners filed their individual returns on a cash receipts and disbursements basis and on a calendar year basis.
The corporation filed its corporation income and declared value excess profits tax return for the taxable year of the corporation ended October 31, 1942, with the collector of internal revenue at Detroit on January 15, 1943. It claimed a deduction for rent paid on the Pontiac premises on the basis of 6 per cent of its gross sales in accordance with the aforementioned lease.
In the spring of 1943 an internal revenue agent commenced an examination of the books of the corporation in connection with the corporation's tax liability for its taxable year ended October 31, 1942. The agent discussed with petitioners and their counsel the reasonableness of the rent which the corporation had deducted and stated that he thought the amount of rent was excessive. As a result of these conversations, petitioners considered the possibility of adjusting their lease if the agent held the rent was excessive.
During its entire fiscal year ended October 31, 1943, the rate upon which the rent was actually computed and paid to the partnership by the corporation was 6 per cent of the gross sales of the corporation, in accordance with the terms of the lease of November 5, 1941.
On November 5, 1943, petitioners held the annual meeting of the board of directors of the corporation. The following extract from the minutes of that meeting recites the action agreed upon regarding the corporation's rent under the terms of the lease of November 5, 1941:
The President, MEYER SIMON, presided and stated that one of the purposes of this meeting was to consider and discuss the possibility that the Treasury Department might not recognize the entire amount of rent paid under the corporation's lease from MEYER, MORRIS and RUBEN SIMON, as a proper corporate deduction for income tax purposes. The president stated further that in the event of the disallowance of any portion of the amount so deducted for rent, the corporation should be entitled to received a refund from the lessors of the amount of such disallowance.
The matter was thereupon discussed with the lessors who were all present and who agreed to make refund of any amount disallowed in the rental deduction for the fiscal year from November 1, 1942 to October 31, 1943, but that there should be no refund and the matter was to be considered closed as to the fiscal year from November 1, 1941 to October 31, 1942, the corporation to absorb any loss during the latter period. It was thereupon understood and agreed that the lessors should refund to the corporation as of October 31, 1943, such portion of the rent for the fiscal year ending that date as might be disallowed by the Treasury Department, such adjustment to be made when the amount had been determined. Counsel for the corporation was to be instructed to draw such amendments to the lease governing the relationship of the parties hereafter, as might be necessary; and the President and Secretary were, by resolution unanimously adopted, authorized to execute such amendment on behalf of the corporation.
On November 12, 1943, the corporation received a 30-day letter from the respondent in which the latter stated that he proposed to disallow a portion of the deduction taken for rental payments during the taxable year ended October 31, 1942, as being excessive. When the corporation protested such a disallowance, a conference was held on January 31, 1944. At this meeting the parties agreed that all amounts deducted by the corporation as rental payments to the partnership in excess of 4 3/4 per cent of the gross sales of the corporation should be disallowed as excessive. The tax liability of the corporation for that year was adjusted accordingly.
At some time subsequent to January 31, 1944, the personal account of each petitioner on the books of the corporation was debited as of December 31, 1943, with an amount representing that petitioner's distributive share of the difference between a rental based on 4 3/4 per cent of the gross sales of the corporation for the period August 1, 1942, to July 31, 1943, and a rental based on 6 per cent of the gross sales for that period. At the same time a corresponding entry was made in the surplus account of the corporation whereby such account was credited with an amount equal to the difference between the 4 3/4 per cent figure and the 6 per cent figure.
The partnership return for the fiscal year ended October 31, 1943, was filed with the collector of internal revenue at Detroit on March 15, 1944, two months subsequent to the due date. The partnership, on this return, reported rental income received from the corporation during such fiscal year in the amount of $97,395.05. This figure represented rent for the period August 1, 1942, to July 31, 1943, computed on the basis of 4 3/4 per cent of the gross sales of the corporation.
On November 11, 1944, petitioners, as officers of the corporation, filed an amended corporation income tax return for the fiscal year ended October 31, 1943, adjusting the corporation's rental deduction from an amount equal to 6 per cent of the gross sales to an amount equal to 4 3/4 per cent of the gross sales.
Each of the petitioners on his individual income and victory tax return for the taxable year ended December 31, 1943, reported his one-third distributive share of the sum of $97,395.05, or $30,741.54, as the net income received by him from the partnership during its fiscal year ended October 31, 1943.
The difference in rent paid to the partnership during its fiscal year ended October 31, 1943, when computed on the basis of 6 per cent of gross sales of the corporation instead of 4 3/4 per cent of the gross sales of the corporation is $23,916.58, distributed to Ruben, Meyer, and Morris Simon in the respective amounts of $7,972.19, $7,972.19, and $7.972.20. These amounts were not reported by the respective petitioners on their returns for the taxable year ended December 31, 1943, and respondent adjusted their incomes accordingly.
OPINION.
HILL, Judge:
The narrow issue for our consideration in this case is whether the execution by the petitioners of a conditional agreement made subsequent to the close of the partnership's fiscal year to refund a portion of the partnership income received during such fiscal year retroactively reduces the distributed income of the partnership for that year.
It is conceded that the partnership during its fiscal year ended October 31, 1943, was paid rent by the corporation in an amount equal to 6 per cent of the gross sales of the corporation during the period August 1, 1942, to July 31, 1943, in accordance with the terms of the lease of November 5, 1941. The record shows no facts to indicate that such rent was received by the partnership subject to any conditions or restrictions. Despite petitioners' contention we find no evidence that at any time during such fiscal year of the partnership its members were under any present or future obligation to refund this income or any portion of it.
But on its tax return for the fiscal year ended October 31, 1943, filed on the cash receipts and disbursements basis, the partnership reported as rental income an amount equal only to 4 3/4 per cent of the gross sales of the corporation, and the individual returns of the partners likewise included only their respective distributive shares of this sum. The basis of such a discrepancy between the income actually received and that reported arises from the fact that subsequent to the close of the partnership's fiscal year and the corporation's fiscal year, but prior to the filing of the partnership return, the partners refunded that amount of rent equal to the difference between 6 and 4 3/4 per cent of the corporation's gross sales. To accomplish this the credit of the partners on the corporate books was lowered and the corporate surplus was raised in an amount equal to the difference between the two percentages.
Such steps were taken as the result of a written agreement between the partners and the corporation on November 9, 1943, wherein it was provided that should the respondent disallow any portion of the deduction taken by the corporation for rental payments during the fiscal year from November 1, 1941, to October 31, 1942, as excessive, then the partners would refund to the corporation as of October 31, 1943, the excess portion of the rent received during the fiscal year ended October 31, 1943. On January 31, 1944, the respondent and the corporation's representatives agreed that rental payments made to the partnership during the fiscal year ended October 31, 1942, in excess of 4 3/4 per cent of gross sales were excessive. After this settlement the partners carried out their agreement of November 9, 1943, with the corporation regarding the rent received during the fiscal year ended October 31, 1943. The partnership's return for this period reflected the result of such action by reporting as rental income an amount equal to 4 3/4 per cent of the gross sales of the corporation.
Such an attempt to retroactively reduce the rental income actually received by the partnership during its fiscal year ended October 31, 1943, has no justification in tax law. It is contrary to the basic principles of the Federal income tax system as explained in Burnet v. Sanford & Brooks Co., 282 U.S. 359, 363, 365:
All the revenue acts which have been enacted since the adoption of the Sixteenth Amendment have uniformly assessed the tax on the basis of annual returns showing the net result of all the taxpayer's transactions during a fixed accounting period, either the calendar year, or, at the option of the taxpayer, the particular fiscal year which he may adopt. * * *
* * * It is the essence of any system of taxation that it should produce revenue ascertainable, and payable to the government, at regular intervals. Only by such a system is it practicable to produce a regular flow of income and apply methods of accounting, assessment, and collection capable of practical operation. * * *
This fundamental doctrine was again recognized by the Supreme Court in Security Flour Mills Co. v. Commissioner, 321 U.S 281, 285-287, when it stated:
* * * But we think it was not intended to upset the well understood and consistently applied doctrine that cash receipts or mature accounts due on the one hand, and cash payments or accrued definite obligations on the other, should not be taken out of the annual accounting system * * * .
* * * The uniform result has been denial both to government and to taxpayer of the privilege of allocating income or outgo to a year other than the year of actual receipt or payment, or, applying the accrual basis, the year in which the right to receive, or the obligation to pay, has become final and definite in amount.
The decisions of the Tax Court are consistent with the accounting principles established by the Supreme Court in the above cases. See Brighton Mills, Inc., 7 T.C. 819, and Baltimore Transfer Co., 8 T.C. 1. Under such a system a subsequent refund of income which was received unconditionally during the taxable year may not reduce the true income to be reported where such a refund is agreed upon after the close of the year.
Counsel for petitioners does not attempt to challenge such a well established doctrine, but bases his case on the allegation that prior to the close of the partnership's fiscal year ended October 31, 1943, the partners made an oral agreement to refund any excess rent received from the corporation during that period. He contends that the agreement of November 9, 1943, between the partners and corporation merely reduced the terms of this oral understanding to writing. If this had occurred, it could well be argued that the rent received by the partnership during the fiscal year ended October 31, 1943, in excess of 4 3/4 per cent of the gross sales of the corporation did not constitute true income, but was a contingent payment based on a condition subsequent. Thus this sum need not have been reported in the partnership return when it was later refunded to the corporation. Such a view is supported by the Court's decision in Eakins v. United States, 36 Fed.(2d) 961. But we can find no evidence of any such oral agreement prior to the close of the fiscal year. Since the written agreement occurred subsequent to the close of the partnership's fiscal year, it can have no retroactive effect to reduce the partnership's rental income based on 6 per cent of gross sales of the corporation which was received during that year.
Other cases cited by the petitioners relate to situations where the taxpayer received advance payments during the taxable year and subsequent to the close of that year repaid them. It is true that such payments do not constitute true income, but these decisions are not controlling here. In the instant case there is no evidence to show that the rent received by the partnership in excess of an amount equal to 4 3/4 per cent of the corporation's gross sales was considered as an advance payment by either the partners or by the corporation.
Although partnerships, as such, are not taxed, that fact does not make inapplicable the rule regarding the determination of true income on the basis of fixed accounting periods. Section 187 of the Internal Revenue Code requires that ‘Every partnership shall make a return for each taxable year, ‘ and section 183 provides that the ‘net income of the partnership shall be computed in the same manner and on the same basis as in the case of an individual.‘ Thus the petitioners may not seize on events occurring after the close of the partnership fiscal year to alter the true income that must be reported by the partnership in its return.
The fact that there was in this case an agreement to make a refund of excess rent and an execution thereof prior to the filing of the partnership return can be of no significance in reporting the true income received during the partnership fiscal year previously ended. A partnership return must reflect only those events which occurred during the past fiscal year and must overlook any later events of which the partners become cognizant before the returns were filed. To decide otherwise would make it possible for partners to gain a downward adjustment of partnership income received in any year by merely delaying the filing of the partnership return until the occurrence of a subsequent favorable turn of events.
Therefore, in the instant case the partnership income for the fiscal year ended October 31, 1943, included rent in an amount equal to 6 per cent of the gross sales of the corporation. We hold that the partnership's return for such fiscal year should have reflected the receipt of this amount. It follows that each petitioner should have reported in his income and victory tax return for the calendar year 1943 an amount representing his distributive share of the net income actually received by the partnership during its fiscal year ended October 31, 1943, including rent based on 6 per cent of the corporation's gross sales. This is made plain by section 188(a) of the code, which states that the amount of partnership income which must be included as income by a partner on his individual return in a case in which the accounting period of the partner differs from that of the partnership is his distributive share of the net income of the partnership for the accounting period of the partnership ending within the taxable year of the partner. See J. H. Goadby Mills, 3 B.T.A. 1245; W. J. Woodruff, 11 B.T.A. 477; Jerome P. Burr, 11 B.T.A. 1009.
The difference in the rent received by the partnership for its fiscal year ended October 31, 1943, when computed on a basis of 6 per cent of gross sales of the corporation instead of 4 3/4 per cent of the gross sales of the corporation is $23,916.58. The proportionate amounts of this sum received by Ruben, Meyer, and Morris Simon during the calendar year 1943 were, respectively, $7,972.19, $7,972.19, and $7.972.20. The petitioners did not report this income on their returns for the taxable year ended December 31, 1943. The Commissioner made a proper adjustment of the income reported by each petitioner to reflect the addition of this omitted item. We conclude that the tax liability determined by the Commissioner as to each petitioner for the year 1943 is correct.
Decisions will be entered for the respondent.