United States Cartridge Co. v. United States

Full title: UNITED STATES CARTRIDGE CO. v. UNITED STATES

Court: Court of Claims

Date published: Apr 6, 1931

48 F.2d 983 (Fed. Cir. 1931)

Opinion

No. H-522.

April 6, 1931.

Suit by the United States Cartridge Company against the United States.

Judgment in accordance with opinion.

This is a tax case. The issues involved concern the proper valuation of inventory and allowance of a claimed deduction from gross income for loss of useful value of factory buildings erected upon leased ground. Plaintiff in its tax return for the year 1918 valued its inventory at market and not cost. The Commissioner valued inventory at cost, on the basis of a firm sales contract to pay cost of materials purchased to perform a contract. Plaintiff claimed obsolescence of buildings erected on leased ground, the claim being predicated upon the fact of termination of the war in that year, the buildings having been erected to perform war contracts. The Commissioner granted annual depreciation of such a sum as at the end of the ten-year term of the lease returned to plaintiff their original cost.

The case was heard upon a report of a Commissioner, from which the court makes the following special findings of fact:

1. The plaintiff, United States Cartridge Company, now is and at all times hereinafter mentioned was, a corporation organized and existing under the laws of the commonwealth of Massachusetts, and now has its principal place of business at Boston, Mass. The plaintiff has at all times borne true allegiance to the government of the United States and has not in any way voluntarily aided, abetted, or given encouragement to rebellion against said government. The plaintiff is the sole and absolute owner of the claim involved in this suit, and has made no transfer or assignment of said claim or any part thereof.

2. In the year 1918 the plaintiff was engaged in the manufacture of ammunition chiefly for small arms. The principal part of its business was the manufacture of ammunition for use in the World War. It also produced some ammunition for commercial purposes. Its accounts were kept on an accrual basis as distinguished from cash basis.

3. The plaintiff kept its accounts and made its tax returns on a calendar year basis. It had duly elected that inventories should be priced for its tax returns for the year 1918 at "cost or market, whichever is lower." On March 22, 1919, the plaintiff filed on Treasury form 1031 — T a tentative income and profits tax return for the calendar year 1918, in which its tax was estimated to be $1,200,000. On December 16, 1919, the plaintiff filed on Treasury form 1120 — A its income and profits tax return for the calendar year 1918, showing a net income of $1,020,374.59, invested capital of $4,676,525.21, excess profits credit of $377,122.02, war profits credit of $470,652.52, and a tax of $509,209.29, which tax was thereafter duly assessed on January 23, 1920. Under its tentative return the plaintiff paid the sum of $900,000, as follows: March 16, 1919, $300,000; June 15, 1919, $300,000; and September 15, 1919, $300,000. The sum of $390,790.71, the difference between the sum of $900,000 so paid and the tax of $509,209.29 so shown, was subsequently applied in part payment of taxes assessed for the year 1919.

4. Upon the review and audit of plaintiff's said return, the Commissioner of Internal Revenue determined the plaintiff's net income for 1918 at $1,792,432.58, invested capital at $4,580,808.44. excess profits credit at $369,464.68, war profits credit at $461,080.84, total tax as $1,152,123.53, and additional tax at $642,914.24. Plaintiff was notified of said determination by letter dated December 4, 1925. A true copy of so much of said letter as is pertinent to the issues in this suit is annexed to the petition herein marked "Exhibit A," and made a part hereof. The Commissioner's determination, of the plaintiff's invested capital, excess profits credit, and war profits credit, and his determination of income with respect to all items other than those on which the petition is based are accepted by both parties as correct for the purposes of this case.

5. In determining the income of the plaintiff for the year 1918, the Commissioner of Internal Revenue placed valuations upon certain goods on hand at the end of the year which were largely in excess of the valuations claimed by the plaintiff to be correct, and also disallowed a deduction claimed by the plaintiff of a portion of the cost of certain buildings erected by the plaintiff on leased land.

6. The additional tax of $642,914.24 determined by the Commissioner as stated above was duly assessed upon the plaintiff on January 16, 1926. Certain overpayments of taxes made by the plaintiff for the years 1917 and 1919, amounting to $412,563.90, were applied upon said additional assessment. On March 24, 1926, the collector of internal revenue for the district of Massachusetts demanded payment of the remainder, $230,350.34, and on March 31, 1926, the plaintiff paid said remainder to said collector under protest.

7. The plaintiff filed with the Commissioner of Internal Revenue waivers of its right to have its taxes for 1918 assessed within the statutory period, including a waiver dated December 27, 1923, filed on December 28, 1923, and a waiver dated November 1, 1924, filed on November 12, 1924, and including also certain subsequent waivers which were in force when the assessment of additional taxes was made on January 16, 1926.

8. On February 29, 1924, the plaintiff filed a claim for the refund of $451,839.51 paid on account of taxes for the year 1918. The Commissioner of Internal Revenue disallowed said claim on January 20, 1926. On January 25, 1927, the plaintiff filed a claim for the refund of $843,589.12 paid on account of taxes for the year 1918. The Commissioner of Internal Revenue disallowed said claim on April 11, 1927.

A true photostat copy of said claim is annexed to the agreed statement of facts filed on November 2, 1928, marked "Exhibit 2," and is made a part hereof by reference.

9. By a contract in writing dated October 5, 1917, between the plaintiff and the Maxim Munitions Corporation, a Delaware corporation, the plaintiff agreed to manufacture and deliver certain 9-millimeter cartridges which the Maxim Munitions Corporation had previously contracted to furnish to the Officine di Villar Perosa, an Italian corporation. These cartridges were of a military type and were to be used by the Italian government in the prosecution of the World War in which that government was engaged. The contract between the Maxim Munitions Corporation and Officine di Villar Perosa, which was dated March 19, 1917, provided for the delivery of 250,000,000 of such cartridges in installments. This contract was twice amended by contracts dated May 31, 1917, and December 14, 1917, respectively. The last amendment reduced the quantity to be furnished to 125,000,000 and substituted a schedule of deliveries under which 119,000,000 cartridges were to be delivered in the months of November, 1917, to May, 1918, inclusive. The remaining 6,000,000 cartridges had been delivered before November, 1917. Copies of contracts and amendments thereof are in the record and are by reference made part of this finding.

10. The faithful performance of the contract dated March 19, 1917, between the Maxim Munitions Corporation and Officine di Villar Perosa, was secured by a bond dated March 22, 1917, executed by the Maxim Munitions Corporation, principal, and the Maryland Casualty Company, the Fidelity Deposit Company of Maryland, and the United States Fidelity Guaranty Company, all of Maryland, sureties in the penal sum of $1,531,250. The Maxim Munitions Corporation deposited with each of the sureties on said bond cash to the full amount of the liability of such surety under said bond, using for the purpose an advance payment of $1,531,250, which had been made to it in accordance with the contract of March 19, 1917. After the amendment of December 14, 1917, to the said contract of March 19, 1917, reducing the quantity of cartridges to 125,000,000, the penal sum of said bond and the respective liabilities of the sureties thereon were, by agreement of the interested parties, reduced by one-half, and one-half of the amount deposited with the sureties was returned to Officine di Villar Perosa. Copy of said bond is attached to the agreed statement of facts and made a part hereof by reference.

11. On or about October 20, 1917, the plaintiff, with the assent of the Maxim Munitions Corporation, entered into agreements dated October 20, 1917, with each of the sureties on the bond referred to in the preceding finding, under which the Maryland Casualty Company paid to the plaintiff $306,250, and each of the other two sureties paid to the plaintiff $153,125 of the cash which had been deposited with them by the Maxim Munitions Corporation as aforesaid, being a total payment to the plaintiff of $612,500. For such moneys the plaintiff gave notes to the respective sureties, which were guaranteed by the National Lead Company, a corporation organized under the laws of the state of New Jersey. A true copy of the contract between plaintiff and the Fidelity Deposit Company is annexed to the petition filed in this cause, marked "Exhibit C," and is made a part hereof by reference, and a true copy of the note given to the said surety and of the guaranty by the National Lead Company is annexed to the said petition, marked "Exhibit D," and is made a part hereof by reference. Contracts and notes in similar form were given by the plaintiff to the other sureties for amounts corresponding to the moneys received by the plaintiff from the respective sureties. The plaintiff has not paid said notes amounting to $612,500.

12. Under the contracts referred to in finding 10 said cartridges were to be inspected by inspectors to be designated by Officine di Villar Perosa at the plant where they were being manufactured. Officine di Villar Perosa was represented in the United States by Joseph S. Josephs, who signed said contract of March 19, 1917, as its agent. In accordance with instructions received by the Maxim Munitions Corporation from Josephs all matters relating to the inspection and acceptance and directions for shipping of the cartridges were handled by the Italian Military Mission, which represented the Italian government in the United States and had an office in New York City.

13. The monthly deliveries of cartridges which were made under said contract of March 19, 1917, and its amendments were as follows:

July, 1917 ... 252,000 Aug. 1917 .... 3,024,000 Sept. 1917 ... 1,512,000 Oct. 1917 .... 1,512,000 Nov. 1917 .... 252,000 Dec. 1917 .... None. Jan. 1918 .... 756,000 Feb. 1918 .... 5,544,000 Mar. 1918 .... 4,536,000 Apr. 1918 .... 7,560,000 May, 1918 .... 8,064,000 June, 1918 ... 8,820,000 July, 1918 ... 10,080,000 Aug. 1918 ... 12,600,000 Sept. 1918 ... 9,072,000 Oct. 1918 .... 10,080,000 Nov. 1918 .... 5,796,000 __________ 89,460,000

On November 22, 1918, Camillo Cerruti, then the chief of the Italian Military Mission and in charge on behalf of the kingdom of Italy of all matters relating to the delivery and acceptance of said cartridges, notified the Maxim Munitions Corporation that the contract with the Officine di Villar Perosa must be considered canceled on account of the failure of the Maxim Munitions Corporation to keep the terms of delivery. A question was raised as to the authority of Mr. Cerruti to cancel the contract, and on November 26, 1918, Officine di Villar Perosa, through Joseph S. Josephs, its duly authorized agent, requested the Maxim Munitions Corporation to discontinue the manufacture of cartridges without prejudice to any rights which the Maxim Munitions Corporation might have by reason of the request, and without prejudice to the rights of either party under the contracts. The Maxim Munitions Corporation then requested the plaintiff to discontinue the manufacture of the cartridges. The manufacture of such cartridges was accordingly stopped by the plaintiff on November 26, 1918.

14. In November and December, 1918, the Maxim Munitions Corporation made requests upon both Joseph S. Josephs as agent of Officine di Villar Perosa and the Italian Military Mission that they proceed to accept deliveries under the contract between the Maxim Munitions Corporation and Officine di Villar Perosa. Neither Officine di Villar Perosa nor the Italian Military Mission was ready to accept and to pay for further deliveries of cartridges after November 26, 1918, and the officers of both the Maxim Munitions Corporation and the plaintiff had notice in November, 1918, of their refusal to accept further deliveries.

15. On December 7, 1918, Joseph S. Josephs, as agent of Officine di Villar Perosa, notified the Maxim Munitions Corporation that he had received instructions from Officine di Villar Perosa that the Maxim Munitions Corporation take up the contract with the Italian Military Mission, and that whatever action the Military Mission might take as to the final disposition of the contract would be approved by both his principal and himself. The Italian Military Mission adhered to the position that Officine di Villar Perosa had a right to cancel the contract of March 19, 1917, as amended, on account of delays in deliveries, and refused to recognize any legal obligation either to accept further deliveries of cartridges or to make any compensation for the materials on hand intended for use in completing the contract or for labor expended on such materials. The plaintiff, through its officers and employees, had notice before the end of 1918 of this attitude of the Italian Military Mission.

16. The Maxim Munitions Corporation was insolvent before the end of 1918 and was not able to accept and pay for further deliveries of cartridges under its contract with the plaintiff or to pay for the materials which the plaintiff had on hand intended for use in said contract. The Maxim Munitions Corporation also owed the plaintiff at this time more than $300,000 for cartridges delivered under the contract which it was unable to pay. The officers of the plaintiff were aware of the inability of the Maxim Munitions Corporation to perform its contract and to pay for said materials before the end of 1918.

17. On May 29, 1919, a petition of involuntary bankruptcy was filed against said Maxim Munitions Corporation (the name of which was changed to Maxim Corporation on March 5, 1919), in the District Court of the United States for the Southern District of New York, and on June 18, 1919, said corporation was adjudicated a bankrupt. On July 10, 1919, plaintiff acquired a conveyance bearing said date from the receiver in bankruptcy of said Maxim Munitions Corporation of the rights of said corporation under the contracts dated March 19, 1917, and amendments thereto dated May 31, 1917, and December 14, 1917, between the Maxim Munitions Corporation and Officine di Villar Perosa. On March 16, 1926, for the sum of $61,250, the plaintiff acquired an unconditional conveyance bearing said date from the trustee in bankruptcy of said Maxim Munitions Corporation of the interest of the bankrupt estate in said contracts, and all rights of action thereunder against the Officine di Villar Perosa, the kingdom of Italy, and the sureties on the bond with the interest of the bankrupt estate in the collateral security held by such sureties.

After July, 1919, the plaintiff attempted to negotiate a settlement with the Italian government, but has never reached any such settlement nor realized anything from such negotiations. Officine di Villar Perosa had no known assets in the United States and no known place of business where service could be made upon it.

A copy of each conveyance mentioned in this finding is annexed to the agreed statement of facts and made a part hereof by reference.

18. In the spring of 1922 it was reported to the officers of the plaintiff that Dr. Roland Ricci, the Italian ambassador to the United States, had reviewed the history of the plaintiff's claim under the conveyance of July 10, 1919, and was disposed to recommend to his government a settlement on the basis of the Italian government receiving $100,000 in cash and all of the completed cartridges, releasing all obligations of the surety companies, and securing such a release from Officine di Villar Perosa. As a part of the proposed settlement, the plaintiff was to be released by the surety companies from all liabilities on its notes and agreements, but was to retain $512,500 of the sum of $612,500 paid to it as aforesaid and all material on hand, except the finished cartridges. The plaintiff was willing to agree to such a settlement, but the Italian government and Officine di Villar Perosa did not approve it. No such settlement has ever been carried out, and negotiations with respect to it were dropped. The plaintiff has received nothing under the conveyances described above. In October, 1923, the three sureties on the bond brought suits against the plaintiff in the superior court for Suffolk county, Mass., upon the respective notes given to them. These suits are still pending undetermined.

19. During the war the United States government demanded priority in shipments of ammunition to it under its contracts with the plaintiff, with the result that the plaintiff was delayed in its manufacture of cartridges under its contract with Officine di Villar Perosa and the quantities specified in said contract for monthly delivery were not met. All this time, however, Officine di Villar Perosa kept pressing the plaintiff for deliveries and accepting deliveries of any quantity the plaintiff could produce up to the time of the armistice, and at the time of the armistice three-fourths of the cartridges to be manufactured under the said contract had been completed and delivered. The plaintiff and the Maxim Munitions Corporation, in its negotiations for settlement of the said contracts, took the position that the contracts had not been breached, and that they were entitled to secure a settlement in accordance with the terms thereof. Mr. Butler Ames, treasurer of the plaintiff corporation from September, 1918, to January, 1920, went to Italy for the purpose of effecting a settlement of the said contract. He resigned from the plaintiff corporation in January, 1920, and at that time the plaintiff still hoped to come to a settlement and had not abandoned its efforts in that direction.

20. On December 31, 1918, the plaintiff had on hand approximately 4,000,000 completed 9-millimeter cartridges which had not been delivered or paid for and a quantity of materials and work in process acquired and worked for the purpose of manufacturing cartridges to be delivered under the contracts for 9-millimeter cartridges. The plaintiff had no purchaser to whom the completed cartridges could be sold, as they were of a special type used only by the Italian government. Most of the material and work in process on hand which had been intended for use under the contract between the plaintiff and the Maxim Munitions Corporation was not suitable for use in manufacturing other ammunition without first being scrapped, as its dimensions were suitable only for 9-millimeter cartridges. On December 31, 1918, the value of such cartridges, material, and work in process, pricing the cartridges at the amount to be paid for finished cartridges under the contract between the plaintiff and the Maxim Munitions Corporation, and pricing the material and work in process at cost, was $274,659.78. On December 31, 1918, the value of said cartridges, materials, and work in process was $79,297.11, at the market without taking into consideration any special value of such goods to the plaintiff arising from said contract, if any such special value existed. In determining the plaintiff's income and profits taxes for 1918 the Commissioner of Internal Revenue valued such cartridges, material, and work in process as of December 31, 1918, at $274,659.78. The plaintiff claimed that said articles should be valued at said date at $79,297.11. Any reduction in such value below the $274,659.78 used by the Commissioner of Internal Revenue would cause an equal reduction in the taxable income of the plaintiff for the year 1918, as determined by the Commissioner of Internal Revenue. The plaintiff has never been able to sell the completed 9-millimeter cartridges, and they are still on hand, except for a few samples. All the work in process and the other material on hand intended for use in completing the contract with the Maxim Munitions Corporation have been sold or used by the plaintiff. The plaintiff did not realize cost for it or anything more than the value of the materials.

21. During the year 1918 the plaintiff was engaged in manufacturing .45-caliber cartridges and artillery primers to be supplied to the United States under certain contracts and understandings made by the plaintiff and representatives of the Chief of Ordnance, acting under the authority of the Secretary of War. These contracts and understandings were as follows:

(a) A contract known as P6489 — 1489 Sa, dated May 6, 1918, executed in accordance with section 3744 of the Revised Statutes, providing for the delivery by the plaintiff to the United States of 60,100,000 .45-caliber cartridges. A true copy of said contract marked "Exhibit 11" is attached to the agreed statement of facts filed on November 2, 1928, and made a part hereof by reference.

(b) An understanding known as the first supplemental contract to contract P6489 — 1489 Sa, made in the year 1918 and before November 11, 1918, by the plaintiff and officers of the Ordnance Department, acting under authority of the Secretary of War, providing for the delivery by the plaintiff to the United States of 75,000,000 .45-caliber cartridges, in addition to those provided for by contract P6489 — 1489 Sa. The terms of said understanding are shown in a draft of contract marked "Exhibit 12" attached to said agreed statement of facts and made a part hereof by reference. Said understanding was never signed by the parties as required by section 3744 of the Revised Statutes ( 41 USCA § 16).

(c) A contract known as P12289 — 3034A, dated July 20, 1918, executed in accordance with section 3744 of the Revised Statutes, providing for the delivery by the plaintiff to the United States of 8,760,000 49-grain artillery primers. A true copy of said contract marked "Exhibit 13" is attached to said agreed statement of facts and made a part hereof by reference.

(d) A contract known as GA — 126, dated August 22, 1917, and executed in accordance with section 3744 of the Revised Statutes, providing for the delivery by the plaintiff to the United States of 5,000,000 110-grain primers, and a supplementary understanding in the form of two letters dated November 15, 1917, and November 28, 1917, increasing the price to be paid for said primers. True copies of said contract and letters marked "Exhibits 14, 15, and 16," respectively, are attached to said agreed statement of facts and made a part hereof by reference. Said supplementary understanding was made by officers of the Ordnance Department acting under authority of the Secretary of War.

(e) A contract known as P12621 — 3124A, dated July 25, 1918, executed in accordance with section 3744 of the Revised Statutes, providing for the delivery by the plaintiff of 1,000,000 110-grain artillery primer bodies to the United States. A true copy of said contract marked "Exhibit 17" is annexed to said agreed statement of facts and made a part hereof by reference.

All of the foregoing are hereinafter referred to as contracts.

22. In December, 1918, the plaintiff received notices from the Ordnance Department requesting suspension of production under said contracts with the United States. Each of these notices requested the plaintiff to suspend immediately further operations under the contract to which it related (except in one case, for the completion of a specified limited number of cartridges), and stated that the request was made with a view to negotiation of a supplemental contract providing for the cancellation (or modification), settlement, and adjustment of the existing contract in a manner which would permit of a more prompt settlement and payment than would be practicable under the existing contract. True copies of said notices are annexed to the petition filed in this cause, marked "Exhibits E, F, G, and H," respectively, and are made a part hereof by reference. The plaintiff complied with the requests contained in these notices.

23. On December 31, 1918, the plaintiff had on hand materials and work in process acquired and worked for the purpose of manufacturing the articles specified in the contracts, but which would not be required in making the reduced quantities of such completed articles which the plaintiff was to deliver according to the terms of such suspension notices. The materials and work in process intended for use under said contracts which are referred to in the petition are the materials which would have been incorporated into the completed articles if the work had not been suspended. Such articles were described in the settlement of the contracts as direct materials. Consumable supplies, such as coal, oil, and similar supplies, which would have been used up in producing the articles, but would not have been incorporated into the finished products, were described in such settlements as indirect materials. No issue is raised in the case as to the valuation of such indirect materials.

24. There was no market on December 31, 1918, for completed articles of the kind specified in said contracts, and it was not possible for the plaintiff to use such materials and work in process advantageously by manufacturing the same into the articles for which they had been intended. There was no way in which the plaintiff could get for its inventories what these inventories had cost the plaintiff except by settlements with the defendant. The material in these inventories was not salable at cost or anyway near cost.

25. During the year 1918 no settlement was made of any of such contracts of the plaintiff, and no negotiations for such settlement took place other than the suspension requests, copies of which are annexed to the petition marked "Exhibits E, F, G, and H," and are made a part hereof by reference.

26. No policy had been adopted by the War Department permitting separate settlements for inventories under suspended contracts in cases where the parties could not agree as to the settlement of a contract as a whole until the issue by the War Department of Supply Circular No. 19, dated March 6, 1919.

27. In addition to the claims which the plaintiff had against the defendant for the cost of unused materials on hand and work done upon the same, the plaintiff had claims under each of said contracts for substantial amounts for other items of damage or compensation. These other claims remained unsettled until the time of the final settlements under the respective contracts. The first of such final settlements took place in December, 1921.

28. In February, 1919, the government assigned a committee to the plaintiff's plant for the purpose of adjusting and settling the contracts between the plaintiff and the government. The said committee was dissolved in September, 1919, and the detail work of effecting a settlement was carried on by the Boston District Claims Board, a governmental agency. There were numerous changes in the personnel of the Boston District Claims Board while negotiations for settlement of the plaintiff's contracts were being conducted. In its negotiations for settlement, the plaintiff also dealt with governmental agencies in Washington, such as the contracting officer, the Ordnance Department Claims Board, the Board of Contract Adjustment, and the War Department Claims Board.

29. The plaintiff had negotiations with the Boston District Claims Board, an agency of the War Department, which resulted in 1920 in an agreement that the defendant would take over and pay for the plaintiff's inventory of direct materials on hand under contract P6489 — 1489 Sa and the first supplemental contract thereto.

30. Contract P6489 — 1489 Sa, which was executed in accordance with statutory requirements, and the supplement to it, which was not so executed, were settled together. This supplement provided for a change in the powder load of certain of the cartridges to be delivered under the original contract, for an increase in the price of such cartridges, and for delivery of an increased quantity. The War Department treated the original contract as so amended as within the provisions of the Act of March 2, 1919, known as the Dent Act ( 40 Stat. 1272 [50 USCA § 80 note]), and settled the contract and its amendment under procedure established to cover contracts not executed in accordance with statutory requirements.

31. In March and April, 1920, agreements with the defendant for acceptance of and payment for the plaintiff's inventories of direct materials on hand under contracts P 12289 — 3034A, GA — 126, and P12621 — 3124A were made in the form of supplemental contracts providing for a method of determining the amounts to be paid to the plaintiff on account of the suspension of production under said contracts. The contracts mentioned are made a part hereof by reference.

32. In the year 1920 the defendant, acting through the War Department, took over the greater part of the direct materials and work in process under said contracts and made payment for the same at cost to the plaintiff, except as stated in finding 33 at the dates and in the amounts shown below:

============================================================================================ | Unworked | Worked | direct | direct | material | material --------------------------------------------------------------|--------------|-------------- P6489 — 1489Sa and supplement: | | Jan. 30, 1920 ............................................ | $426,864.61 | ............. July 28, 1920 ............................................ | 4,875.07 | $80,189.85 P12289 — 3034A: Sept. 20, 1920 .............................. | 23,581.72 | 37,978.72 GA — 126: June 11, Sept. 20, 1920 ........................... | 3,699.59 | 1,504.32 P12621 — 3124A: Sept., 1920 ................................. | 6,377.33 | 9,489.13 |--------------|-------------- | 465,398.32 | 129,162.02 |==============|============== | ............ | 465,398.32 | ............ | 129,162.02 |--------------|-------------- Total payment in 1920 for direct worked and unworked material | ............ | 594,560.34 -------------------------------------------------------------------------------------------- 33. The amounts as stated in finding 32 did not include anything for cost of labor and overhead expense incurred by the plaintiff in working the worked material, but included the cost of the raw material in such worked material. There were many unsettled differences between the parties at the time as to the amounts to be allowed for such labor and expense. Such differences continued until the final settlements under the respective contracts, and the plaintiff was not paid anything for such labor and expense until the final settlements. In addition to the direct materials and work in process taken over and paid for as stated above, there were other similar items for which the plaintiff claimed reimbursement, but which the defendant did not at the time accept or pay for. In the final settlements made in 1921 and 1922, the defendant agreed to pay for certain of these items. The defendant declined in said settlements to take over and to pay for a part of such material and work in process on hand on December 31, 1918, or to reimburse the plaintiff for any loss on account of such part, basing such refusal on various grounds, including the ground that the amount on hand exceeded the amount required to perform the contracts under consideration.

34. Under contract P6489 — 1489 Sa there was a controversy between the parties as to whether any allowance should be made to the plaintiff for useful component parts contained in certain cartridges which had been rejected because of defective primers, but which could be reworked and made into acceptable cartridges. The plaintiff had a quantity of these rejected cartridges on hand on December 31, 1918, for which the plaintiff claimed from the government about $58,000 based on the cost to the plaintiff of the reclaimable component parts in these rejected cartridges. During the war the government accepted such reworked cartridges and paid the full contract price therefor. The War Department declined to take over this material in 1920, when the greater part of the material under contract P6489 — 1489 Sa was taken over by the government. In the final settlement of said contract in December, 1921, the plaintiff's claim for this item was compromised, and the government allowed $28,915.44 for the reclaimable component parts in these rejected cartridges, and the plaintiff retained the cartridges. These cartridges were later sold for their scrap value, which was much less than the balance of the plaintiff's claim.

35. The preparation and presentation of the plaintiff's claims under its various war contracts with the defendant in accordance with the requirements of the War Department and the government audit of those claims required a large amount of work extending over several years. The plaintiff had claims against the defendant under contracts other than those enumerated above. One of the contracts under which the plaintiff had such claims, known as 14066, was a cost-plus contract and was several times as large as the contracts involved in the present case taken together. Certain costs had to be apportioned between contract 14066 and the other business of the plaintiff. At times the plaintiff employed 35 or 40 persons in its department of accounts and settlements. The plaintiff spent approximately $400,000 (exclusive of legal expenses) in meeting the requirements of the War Department as to the proof of its claims under its various contracts, including, among others, contract 14066 and the contracts involved in the present case. The defendant had a staff of accountants at the plaintiff's plant at Lowell, Mass., which had been there during the war and remained until about July, 1921, when it moved to Watertown, Mass. These accountants were working on the plaintiff's claims as late as August, 1922.

36. Before the plaintiff had reached a final settlement of any of the contracts it received various letters from government agencies relating to the necessity of having its claims settled by specific dates. About July 29, 1919, the plaintiff received a letter from the Boston District Ordnance Office, signed by the ordnance district chief, stating that the various claims boards would probably cease to exist on September 30, 1919. About August 20, 1919, the plaintiff received a letter from the Boston District Claims Board stating that that Board would be unable to consider any claims which were not presented before September 30, 1919. It was impossible for the plaintiff to get its claims completed before September 30, 1919. The Board was in fact, however, continued after that date.

37. Soon after March 18, 1920, the plaintiff received a letter from the Boston District Claims Board stating that, from the most reliable information which the Board was able to secure, outstanding appropriations on which it would be possible to pay the plaintiff's claims would be canceled on June 30, 1920, and that, in the event of the cancellation of the allotments occasioned by the expiration of the appropriation period, funds could be secured only by special act of Congress. About May 22, 1920, the plaintiff received a letter from the Boston District Claims Board stating that its office had been directed by the Claims Board at Washington to notify contractors that the appropriations allotted for settlement of claims on suspended contracts would lapse on June 30, 1920, and thereafter payment could only be secured through agencies other than the War Department. It was not possible for the plaintiff to complete the settlement of its claims by June 30, 1920. About January 6, 1921, the plaintiff received a letter from the office of the Chief of Ordnance at Washington inclosing a copy of a memorandum dated December 21, 1920, from Newton D. Baker, Secretary of War, to the Assistant Secretary of War. This memorandum stated that the preceding year the Department had urged upon Congress that appropriations be made available during the current year for the payment of settlements of war-time contracts, and that Congress had done so and the funds were available until June 30, 1921. The memorandum also stated that the Department would not ask Congress to extend this privilege, and that claimants should be notified that appropriations lapsed on June 30, 1921. It was not possible for the plaintiff to reach settlements of the contracts before June 30, 1921. As it turned out, the appropriations were extended beyond June 30, 1921, and the plaintiff received payments after that date.

38. The plaintiff eventually obtained final settlement of all the contracts under written awards or agreements made by or under the authority of the Secretary of War, excepting, however, a claim under contract GA — 126, relating to the price of articles which had been delivered. The dates of such awards or agreements and the total amounts allowed in each for direct materials, worked and unworked, for labor and overhead on worked direct materials and for other claims, are stated below. The amounts allowed for materials include the items which had been paid for in 1920 as stated in finding 32:

========================================================================================================= | Unworked | Worked | | | direct | direct | Labor and | Other | materials | materials | overhead | claims ---------------------------------------------------|-------------|-------------|------------|------------ Contract P6489 — 1489 Sa and supplement: Final | | | | award dated Dec. 23, 1921; total awarded, | | | | $907,546.94 ..................................... | $442,153.76 | $100,040.35 | $78,487.01 | $286,865.82 Contract P12289 — 3034A: Final settlement contract | | | | approved Feb. 6, 1922; total settlement | | | | agreed upon, $175,160.86 ........................ | 23,581.72 | 57,169.58 | 22,254.09 | 72,155.47 Contract GA — 126: Final settlement contract | | | | dated June 8, 1922; total settlement agreed | | | | upon $31,098.53 ................................. | 3,699.59 | 1,504.32 | 3,247.02 | 22,647.60 Contract P12621 — 3124A: Final settlement approved | | | | Dec. 23, 1921; total settlement agreed | | | | upon, $40,812.02 ................................ | 19,457.08 | 9,456.03 | 3,947.87 | 7,951.04 |-------------|-------------|------------|------------ Totals ....................................... | 488,892.15 | 168,170.28 | 107,935.99 | 389,619.93 --------------------------------------------------------------------------------------------------------- Total allowed on all items on above contracts $1,154,618.35. In the final settlements made in 1921 and 1922, the United States reimbursed the plaintiff for the cost of certain portions of its inventory or for a part of said cost less the salvage value of such portions, and in the latter case the plaintiff retained the material for which it had been so reimbursed.

39. The War Department withheld certain sums due to the plaintiff under two of said final settlement contracts, claiming the right to withhold the same on account of alleged overpayments for completed articles delivered under contract GA — 126. The question at issue was whether an agreement made by certain letters exchanged between the Ordnance Department and the plaintiff, providing for an increase of 1.8 cents in the price of each primer delivered under contract GA — 126, was valid. Most of the primers delivered under contract GA — 126 had been paid for in accordance with this agreement. The War Department claimed that the payment of the increased amount was illegal and withheld $24,108.66, being the entire unpaid amount due to the contractor under the settlement contract relating to contract GA — 126, and $28,482.39 of the balance due under the settlement contract relating to contract P12289 — 3034A. The plaintiff subsequently brought suit in the Court of Claims to recover the amounts withheld, recovered judgment in full in the year 1926, and received payment.

40. The amounts allowed for direct materials and for labor and overhead on such materials in the final settlements of the contracts included allowances for some material which was not in the inventory of the plaintiff at the end of the year 1918, because at that time it was the property of subcontractors. This material later became the property of the plaintiff through settlements made by the plaintiff with the subcontractors.

41. The value on December 31, 1918, of the material and work in process owned by the plaintiff which had been acquired and worked for the purpose of manufacturing the articles specified in the contracts and understanding, pricing at cost those portions of the same which were subsequently taken over at cost by the United States, or for which the plaintiff was subsequently reimbursed at cost as stated above, pricing the material for which the plaintiff was paid a part of the cost at the amount received therefor in said settlements, and pricing the remainder thereof at its fair market value on said December 31, 1918, was $732,088.62. The fair market value of said materials and work in process on December 31, 1918, without taking into consideration any special value of such goods to the plaintiff arising from said contracts, if any such special value existed, was $231,615.43. In determining the plaintiff's income and profits taxes for the year 1918, the Commissioner of Internal Revenue valued such materials and work in process as of December 31, 1918, at $732,088.62. The plaintiff claimed that said articles should be valued at $231,615.43. Any reduction in valuation of said materials and work in process below the amount used by the Commissioner of Internal Revenue would cause an equal reduction in the taxable income of the plaintiff for the year 1918.

42. The market value on December 31, 1918, of the plaintiff's inventory of materials and work in process intended for use under the contracts was $231,615.43.

43. For many years prior to the beginning of the World War in 1914 the plaintiff had been engaged in the manufacture of ammunition for small arms for ordinary commercial purposes. The business was principally carried on at Lowell, Mass., in buildings on Lawrence street, which the plaintiff rented from the Wamesit Power Company. There was also a small shooting range at South Lowell. The market for such ammunition was limited. The business was highly competitive and was not profitable in the years immediately preceding the war. The company had a deficit in the years 1911, 1912, 1913, and 1914. In 1913 and 1914 the plaintiff employed between 350 and 400 persons.

44. For the purpose of filling war orders which the plaintiff had received and expected to receive while the war continued, the plaintiff constructed buildings upon the lands of the Wamesit Power Company at Lowell, and at South Lowell, Mass., and equipped these buildings with machinery for the manufacture of ammunition for small arms and similar munitions of war, under an agreement in the following terms:

"Whereas, the United States Cartridge Company wishes to increase the size of some of the buildings now rented from the Wamesit Power Company and to erect new buildings and make other improvements on the property of the Wamesit Power Company, and the Wamesit Power Company does not wish to make the necessary investment therefor, it is therefore agreed that the United States Cartridge Company may erect and occupy such buildings for ten years from January first, nineteen hundred and fifteen, paying no rent therefor to the Wamesit Power Company for said ten years, and at the end of said ten years the buildings and improvements shall become the property of the Wamesit Power Company and shall thereafter be subject to rental by the Wamesit Power Company.

"If the United States Cartridge Company shall desire to vacate said buildings or any part of them before the end of the term of ten years, the Wamesit Power Company shall give the United States Cartridge Company all possible assistance in renting said buildings for the remainder of the term of ten years, the rental to be paid to and be for the benefit of the United States Cartridge Company.

"The United States Cartridge Company shall pay the taxes on the buildings, shall keep the buildings fully insured, and in case of loss the United States Cartridge Company shall replace the buildings in as good condition as before, or if the United States Cartridge Company shall not desire to rebuild, the Wamesit Power Company shall have the option of taking the amount received from insurance and rebuilding or not."

45. The amount expended by the plaintiff in the construction of said buildings at Lowell and at South Lowell and the years in which said amounts were spent are as follows:

======================================================== | Expenditures | Expenditures Year | at Lowell | at So. Lowell --------------------------|--------------|-------------- 1914 .................... | $ 0.00 | $ 4,088.79 1915 .................... | 296,256.40 | 295,457.37 1915 (garage) ........... | 41,017.03 | ............. 1916 .................... | 99,657.20 | 65,950.49 1917 .................... | ............ | 72.21 |--------------|-------------- | 436,930.63 | 365,568.86 | ............ | 436,930.63 |--------------|-------------- Total amount expended ... | ............ | 802,499.49 --------------------------------------------------------

46. When the plaintiff built said new buildings it had no use for them except for war purposes. During the World War the plaintiff had a large and profitable business in ammunition intended for use in the war, first for European governments, and later for the United States, after the United States entered the war. Its employees increased in number to 7,000 in 1916 and to about 15,000 in 1918. In 1913 and 1914, before the war began, the plaintiff occupied in its business 89,074 square feet of floor space at Lowell and South Lowell. During the war the plaintiff occupied said new buildings which it constructed to their capacity and also rented additional buildings from the Wamesit Power Company. Some of the buildings which the plaintiff had occupied in 1914 were torn down to make room for said new buildings. By the end of 1916 the plaintiff was occupying 422,302 square feet of floor space at Lowell and South Lowell, of which 282,968 square feet were contained in said new buildings erected by the plaintiff, and the remainder, 139,334 square feet, was rented from the Wamesit Power Company. After these buildings were constructed they were all used by the plaintiff up to the time when the United States entered the war and during the years 1917 and 1918.

47. Up to the time of the armistice the plaintiff had orders equaling its capacity and had no way of knowing when the demand for ammunition for war purposes would stop. After the armistice the plaintiff received no new orders for military ammunition and did not expect any. The plaintiff's officers had no expectation of continuing the production of military ammunition after the armistice except perhaps to clean up some material already in the plant and did not expect to so continue to any material extent.

48. In its income tax return filed for the year 1916 the plaintiff claimed a deduction of $973,628.83 for amortization of its plant created for war purposes. In April, 1917, this return was examined by a revenue agent acting under the Commissioner of Internal Revenue, who notified the plaintiff that the cost of the war plant should be charged off over the period ending on December 31, 1924, and that only a proportionate part could be deducted in 1916. The plaintiff acquiesced in this view so far as such deduction in the year 1916 was concerned, and filed an amended return for 1916 in accordance with it, and in consequence paid an additional tax for 1916 of $18,099.18.

49. The buildings with respect to which the plaintiff is claiming a loss of useful value are the leasehold buildings at Lowell and South Lowell, Mass., which were erected by the plaintiff in the years 1914 to 1916 at a cost of $802,499.49 and which had an area of 282,968 square feet. The depreciation allowed in the settlement of the plaintiff's income and profits taxes for the years 1914 to 1917, inclusive, on account of the cost of the buildings, was $197,107.74. In the settlement of its 1918 income and profits taxes the plaintiff claimed that the value on December 31, 1918, of the plaintiff's right to use said buildings for peace-time purposes for the remainder of the term of the lease was $190,969.86, and asserted that it was entitled to deduct as a loss of useful value for the year 1918 the difference between the depreciated value of the said buildings (cost $802,499.49, less depreciation to December 31, 1917, of $197,107.74) and the alleged residual value thereof, $190,969.86, making a deduction of $414,421.89. The Commissioner of Internal Revenue refused to allow any deduction for loss of useful value, ruling that the plaintiff was not entitled to such an allowance because it had not abandoned the use of said buildings or permanently devoted them to a radically different use, but allowed $86,484.54 for depreciation of said buildings for the year 1918. The remainder of the plaintiff's claim of $414,421.89, namely, $327,937.35, was not allowed in any form. Said allowances for depreciation of $197,107.74 and $86,484.54 were reached by allowing depreciation on each of the buildings at a rate so calculated that at the expiration of the lease the cost of each building would be extinguished in equal annual installments. The deduction from income for 1918 claimed by the plaintiff on account of the cost of said buildings erected on leased land was charged off on the plaintiff's books.

In the income tax returns filed by the plaintiff for the years 1919 to 1924, inclusive, the plaintiff claimed deductions on account of the cost of the buildings erected by the plaintiff on land leased from the Wamesit Power Company aggregating $190,969.86, being the amount claimed by the plaintiff to be the residual value on December 31, 1918, of the right to use said buildings during the remainder of the lease. The total amount so claimed for the years 1919 to 1924 was allocated proportionately between said years. The Commissioner of Internal Revenue, in determining the taxes of the plaintiff for said years 1919 to 1924, increased the deduction for said years on account of the cost of said buildings by $327,937.35, the amount of the deduction which the Commissioner had disallowed for the year 1918.

On January 16, 1926, when the assessment of additional taxes was made on the plaintiff for the year 1918, the Commissioner had made no final determination of the income or profits taxes of the plaintiff for the years 1920 to 1924, inclusive, and the statute of limitations was not a bar to the assessment of proper taxes for such years and for the year 1919, as the plaintiff had filed agreements to waive the statute of limitations with respect to the years 1919, 1920, and 1921, to which said statute would otherwise have applied, valid as to the year 1919 until July 29, 1926, and as to the years 1920 and 1921 until December 31, 1926.

The respective floor areas of the garage and other buildings constructed at Lowell and the buildings constructed at South Lowell, and the amount of depreciation allowed thereon to December 31, 1918, by the Commissioner of Internal Revenue, are as follows:

====================================================== | | Depreciation | | allowed to | Floor area | December | | 31, 1918 -------------------|--------------------|------------- Garage ........... | 22,960 sq. ft. .. | $ 15,111.53 Other buildings at | | Lowell .......... | 156,960 sq. ft. .. | 138,573.08 Buildings at So. | | Lowell .......... | 103,048 sq. ft. .. | 129,907.67 |________ | ___________ | 282,968 " " .. | 283,592.28 ------------------------------------------------------

50. After the armistice the plaintiff continued its commercial ammunition business. Its position with respect to this business was difficult, as each of the five munition manufacturers in the country had a capacity which was much greater than in peace times and each strove to get as much of the business as possible.

51. No income could be derived by renting the new buildings, as there was no demand for buildings of this character. Most of the buildings rented from the Wamesit Power Company had been incorporated into the new buildings so that the two had to be used as a unit unless the plant was revamped, and this was not considered or done. Plaintiff had in the new buildings and in the buildings which it rented more space than it needed for its commercial ammunition business.

The actual sales of ammunition for 1924 were less than those for the preceding year. The plaintiff did fill the new buildings and those which it rented by manufacturing in addition to ammunition certain articles which the plaintiff had not made before the war, including radiators, radiator tubes, phonograph motors, paper boxes, and certain other articles. The volume of such other business was small compared with the plaintiff's ammunition business. Approximately ninetenths of the plaintiff's sales were of ammunition in each of the years 1920 to 1924, inclusive. The plaintiff realized no net return from this other business, but suffered a loss in the manufacture of each of such other lines of goods in each year. The plaintiff also made no profit from its manufacture of commercial ammunition after the war, but suffered a loss on all its manufacturing operations in each of the years 1919 to 1924, inclusive.

52. From a mechanical point of view there is no difference between the manufacturing of military ammunition and commercial ammunition, except that the same machinery will produce more military ammunition because there are fewer sizes and types of the former than the latter. The war business came to the manufacturer. There was no selling to be done. Price was relatively no object. Production was of a few types in large volume, which made costs much lower. In case of the commercial ammunition produced in the prewar and postwar periods there were a large number of kinds of articles for all varieties of arms, the demand for which was governed by the whim of the public who shot one load one year and another load another year. Competition was severe and keen. The industry was believed to be declining, and the only way to get new business was to take it away from competitors.

53. The value of the plaintiff's right to use the buildings erected by it on the land of the Wamesit Power Company as aforesaid for the six years of its lease remaining after December 31, 1918, did not exceed $190,969.86.

54. The fair annual value of the plaintiff's right to use the buildings erected by the plaintiff on the land of the Wamesit Power Company as aforesaid (including the garage) during the six years following December 31, 1918, on the terms under which the plaintiff held such buildings, was $31,126.48, and the value of such right for said six years was $186,758.88.

55. The fair annual value of the plaintiff's right to use the garage erected by the plaintiff on land of the Wamesit Power Company for the six years following December 31, 1918, on the terms under which the plaintiff held such buildings, was $2,525.60 and the value of such right for said six years was $15,153.60.

56. The plaintiff had erected the garage for storage and services of its own trucks and automobiles used in its war business. It had no need for the garage before or after its war business. From 1919 to October, 1923, the building was operated as a public garage through a subsidiary company. An agency for the sale of certain automobiles was also conducted. It was used in its entirety for these purposes. This garage business showed a loss and the plaintiff realized no net return from the garage until October, 1923, when it was leased to others at a rental of $300 a month, the plaintiff paying the taxes and insurance on the building. A fair allowance for taxes, insurance, and necessary repairs would be at least 5 cents per square foot annually, or $1,148 a year. The net return from such rental of the garage was at the rate of between 10 cents and 11 cents a square foot annually.

57. Under date of November 15, 1922, the plaintiff, in response to an inquiry from the Bureau of Internal Revenue, furnished schedules which had been prepared by certified accountants showing as nearly as could be ascertained from the company's records the number of square feet of floor space allotted to the various departments of the plaintiff's business during the periods between January 1, 1919, and November, 1922. The figures contained in the said schedules were based on the company's records, and not on actual measurement taken at that time, and, although they are inexact in some particulars, they show with substantial accuracy the proportionate part of space allotted to various departments and the proportionate part of idle and vacant space not allotted to operating departments in plaintiff's leasehold and annual rental buildings. In the said schedules the buildings erected by the plaintiff at Lowell and South Lowell, Mass., and occupied rent free, are referred to as leasehold buildings as distinguished from the buildings at Lowell, Mass., which the plaintiff did not construct and which were occupied on an annual rental basis. In October, 1922, or thereabouts, a complete rearrangement and reallocation of space for the plaintiff's various activities was made in the leasehold and annual rental buildings. The schedules furnished the Bureau of Internal Revenue by the plaintiff on November 15, 1922, were accompanied by a letter signed by W.R.B. Whittier, treasurer of the company, addressed to William F.R. Griffith, an appraisal engineer then employed in the Bureau of Internal Revenue.

Analysis of use of plaintiff's leasehold and annual rental buildings at Lowell and South Lowell, Mass., and schedules showing type of construction of buildings, the said plants, floor area of each building, and total square feet of idle or vacant space in each building at the beginning of each of the years 1919 to 1922, inclusive, and at October, 1922, prepared from the said schedules furnished by the plaintiff on November 15, 1922, are annexed to the additional agreed statement of facts filed on July 5, 1929, marked "Exhibits 20 to 24," and are made a part hereof by reference.

58. At the periods stated below, the kinds of use and the percentage of space allotted to each kind of use in plaintiff's leasehold buildings at Lowell and South Lowell, Mass. (upon which the plaintiff claims loss of useful value), were as follows:

======================================================================================================= | | | Percentage of use | New layout, Kind of use | Jan., | Jan., |-------------------------| Oct., 1922 | 1919 | 1920 | Jan., 1921 | Jan., 1922 | ------------------------------------------------|-------|-------|------------|------------|------------ Machine occupied space: | | | | | Ammunition manufacture ..................... | 15% | 26% | 38% | 38% | 28% Radiator, motor, and paper-box manufacture, | | | | | and wasting, annealing and hardening .... | 1% | 4% | 11% | 13% | 7% |-------|-------|------------|------------|------------ Total machine occupied space .............. | 16% | 30% | 49% | 51% | 35% Service departments ........................... | 23% | 25% | 24% | 24% | 12% |-------|-------|------------|------------|------------ Total manufacturing space (machine occupied | | | | | and service departments) ................. | 39% | 55% | 73% | 75% | 47% Extraneous use of space ....................... | 21% | 24% | 21% | 21% | 27% |-------|-------|------------|------------|------------ Total company use of space ................ | 60% | 79% | 94% | 96% | 74% Government storage (machinery and materials) | 28% | 11% | .......... | .......... | ........... |-------|-------|------------|------------|------------ Total use of buildings .................... | 88% | 90% | 94% | 96% | 74% Idle and vacant space ......................... | 12% | 10% | 6% | 4% | 26% |-------|-------|------------|------------|------------ Total available space ..................... | 100% | 100% | 100% | 100% | 100% -------------------------------------------------------------------------------------------------------

Not all the space allotted to the various departments was actually used.

59. At the periods stated below, the kinds of use and the percentage of space allotted to each kind of use in plaintiff's annual rental buildings at Lowell, Mass., were as follows:

====================================================================================================================== | | | Percentage of use | Kind of use | Jan., 1919 | Jan., 1920 |------------|------------| New layout, | | | Jan., 1921 | Jan., 1922 | Oct., 1922 -----------------------------------------------------|------------|------------|------------|------------|------------ Machine occupied space: | | | | | Ammunition manufacture .......................... | 34% | 16% | 18% | 26% | 20% Radiator, motor, and safety-razor manufacture ... | .......... | 11% | 23% | 9% | 4% |------------|------------|------------|------------|------------ Total machine occupied space ................... | 34% | 27% | 41% | 35% | 24% Service departments ................................ | 19% | 27% | 38% | 42% | 46% |------------|------------|------------|------------|------------ Total manufacturing space (machine | | | | | occupied and service departments) ............. | 53% | 54% | 79% | 77% | 70% Extraneous use of space ............................ | 13% | 19% | 15% | 5% | 11% |------------|------------|------------|------------|------------ Total company use of space ..................... | 66% | 73% | 94% | 82% | 81% Government storage ................................. | 25% | 5% | .......... | .......... | ........... |------------|------------|------------|------------|------------ Total use of buildings ......................... | 91% | 78% | 94% | 82% | 81% Idle and vacant space .............................. | 9% | 22% | 6% | 18% | 19% |------------|------------|------------|------------|------------ Total available space .......................... | 100% | 100% | 100% | 100% | 100% ---------------------------------------------------------------------------------------------------------------------- Not all the space allotted to the various departments was actually used.

60. At the periods stated below the percentage of space allotted directly to machinery for ammunition manufacture in plaintiff's leasehold buildings to the total space allotted for such purpose in all buildings (leasehold and annual rental buildings) was as follows:

=============================================================== Jan., 1919 | Jan., 1920 | Jan., 1921 | Jan., 1922 | New layout, | | | | Oct., 1922 -----------|------------|------------|------------|------------ 48% | 77% | 81% | 81% | 80% ---------------------------------------------------------------

61. At the periods stated below the percentage of space allotted directly to the machinery for all types of manufacture in plaintiff's leasehold buildings to the total space allotted for such purpose in all buildings (leasehold and annual rental buildings) was as follows:

=============================================================== Jan., 1919 | Jan., 1920 | Jan., 1921 | Jan., 1922 | New layout, | | | | Oct., 1922 -----------|------------|------------|------------|------------ 49% | 70% | 71% | 81% | 80% ---------------------------------------------------------------

62. Of the buildings which plaintiff occupied on an annual rental basis, 96,494 square feet of a total area of 139,334 square feet were incorporated into certain leasehold buildings at Lowell, Mass., so that such combined leasehold and annual rental buildings had to be used as a unit unless the plant was revamped. The area of the leasehold buildings at Lowell so incorporated was 147,064 square feet of a total area of leasehold buildings at Lowell of 179,920 square feet. Of the annual rental buildings so incorporated, 47,816 square feet were of brick construction and 48,678 square feet were of wood construction; and of the leasehold buildings so incorporated, 139,293 square feet were of brick construction and 7,771 square feet were of wood construction.

63. In the latter part of 1921 plaintiff terminated the rental of 38,469 square feet of annual rental space at Lowell, Mass. There were no company constructed leasehold buildings incorporated with such annual rental buildings. The leasehold buildings at South Lowell constituted a separate and distinct plant containing no annual rental buildings. During the war the leasehold buildings at South Lowell were used for the manufacture of munitions.

64. The types of construction of plaintiff's leasehold and annual rental buildings and relative percentage of each type of construction are as follows:

====================================================== | Concrete | Brick | Frame ---------------------------|-----------|-------|------ Leasehold buildings: | | | Lowell ................ | 15% | 78% | 7% South Lowell .......... | ......... | 62% | 38% Annual rental buildings | 15% | 39% | 46% ------------------------------------------------------

65. The plaintiff never ceased in its efforts to increase its sales of commercial ammunition. The amount of the plaintiff's commercial ammunition business from 1913 to 1924 is shown by the following statistics, the figures representing cartridges produced and blank spaces indicating no record of production for such period:

======================================================== | Kind of ammunition |-------------------------------------------------- Year | Shot shell | Rim fire | C.f. | C.f. | | | pistol | military -----|------------|-------------|------------|---------- 1913 | .......... | 77,192,000 | 11,867,000 | ......... 1914 | 48,691,570 | 117,719,000 | 14,659,000 | ......... 1915 | 64,590,136 | 123,850,000 | .......... | ......... 1916 | 70,758,703 | 114,237,000 | 23,807,000 | 3,105,000 1917 | 49,549,564 | ........... | .......... | ......... 1918 | 64,725,560 | 62,428,000 | 86,143,000 | 173,500 1919 | 92,083,535 | 132,392,000 | 31,461,000 | 2,628,000 1920 | 69,720,786 | 170,943,190 | 36,973,150 | 3,253,931 1921 | 66,671,323 | 64,641,731 | 10,206,751 | 1,188,951 1922 | 71,798,727 | 136,338,825 | 16,881,000 | 1,993,760 1923 | 78,594,800 | 178,875,600 | 17,425,459 | 1,952,030 1924 | 59,825,699 | 275,424,900 | 19,863,150 | 1,961,200 --------------------------------------------------------

66. At the end of 1918 all of the space in plaintiff's leasehold buildings at Lowell and South Lowell, Mass., was being utilized either for manufacturing or storage purposes.

67. The premises rented by the plaintiff from the Wamesit Power Company for the years 1914 to 1924 (excluding the land on which the new buildings were constructed) were not held under any written lease, but the plaintiff was a tenant at will throughout the period. The number of square feet of floor space on January 1st of each year in the rented buildings (as distinguished from the leasehold buildings constructed by the plaintiff) and the annual rental for the same were as follows:

========================================================================================= | Floor area of bldgs. on January | Annual | Rental per | 1 | rental | square foot --------------------------|-----------------------------------|-------------|------------ 1914 .................... | 89,074 sq. ft. ................. | $ 9,560.00 | $0.1073 1915 .................... | 65,674 sq. ft. ................. | 12,000.00 | .1827 1916 .................... | 97,804 sq. ft. ................. | 15,766.00 | .1612 1917 .................... | 139,334 sq. ft. ................. | 20,188.00 | .1448 1918 .................... | 139,334 sq. ft. ................. | 20,188.00 | .1448 1919 .................... | 139,334 sq. ft. ................. | 20,188.00 | .1448 1920 .................... | 139,334 sq. ft. ................. | 20,188.00 | .1448 1921 .................... | 139,334 sq. ft. ................. | 20,188.00 | .1448 1922 .................... | 102,709 sq. ft. ................. | 17,488.00 | .1702 1923 .................... | 102,709 sq. ft. ................. | 17,488.00 | .1702 1924 .................... | 101,209 sq. ft. ................. | 17,188.00 | .1698 | |-------------|------------ Average, 1914-1924 ... | ................................. | ........... | .1516 ----------------------------------------------------------------------------------------- The landlord paid the taxes and insurance on these buildings. The premises rented included, not only buildings of the area which had been stated, but the right to use the railroad sidetrack on the premises, the use of water from the Wamesit Canal for industrial purposes, and also the right to use certain land not covered by buildings.

68. The comparative sales of ammunition and subsidiary products manufactured by plaintiff from the years 1920 to 1924 were as follows:¹

1 Figures for 1920 are gross from which discounts and allowances of $183,085.72 should be deducted. For remaining years figures are net value.

================================================================================================================= | 1920 | 1921 | 1922 | 1923 | 1924 ---------------------------|----------------------|---------------|---------------|---------------|-------------- Ammunition ............... | $3,611,478.13 | $2,006,237.21 | $2,747,696.68 | $2,853,460.81 | $2,728,890.14 Radiator tubes cores ... | 113,546.39 | 139,810.27 | 207,545.37 | 269,099.22 | 228,156.26 Motors ................... | 65,760.42 | 52,018.38 | 94,689.77 | 78,389.71 | 61,948.72 Paper boxes .............. | 54,749.06 | 55,165.20 | 28,489.31 | ............. | ............. |----------------------|---------------|---------------|---------------|-------------- Totals .............. | 3,845,534.00 | 2,253,231.06 | 3,078,421.13 | 3,200,949.74 | 3,018,995.12 -----------------------------------------------------------------------------------------------------------------

The manufacture of radiators started late in 1917. The manufacture of paper boxes started in February, 1920, and ceased as of October 7, 1922. The manufacture of motors started early in 1920 and was discontinued January 1, 1925.

H. Le Baron Sampson, of Boston, Mass. (Jay B. Angevine, of Boston, Mass., on the brief), for plaintiff.

Fred K. Dyar and Isadore Graff, both of Washington, D.C., Charles B. Rugg, Asst. Atty. Gen. (Ottamar Hamele, of Washington, D.C., on the brief), for the United States.

Argued before BOOTH, Chief Justice, and WILLIAMS, LITTLETON, and GREEN, Judges.

BOOTH, Chief Justice.

This case presents the determination, under the revenue laws and regulations of the Commissioner of Internal Revenue, of plaintiff's tax liability for the year 1918.

The plaintiff is a Massachusetts corporation and during the late World War was engaged in the manufacture of ammunition to be used both in this country and abroad. In making its tax return for the calendar year 1918 two contentions arose as to the proper valuation of its inventory for the year and the denial by the Commissioner of a deduction from gross income for the year of the cost of buildings erected upon leased grounds.

No jurisdictional question arises and the case depends solely upon the issues stated. The facts which follow must be stated in detail.

The plaintiff's books of account were kept upon an accrual basis. On March 19, 1917, the Maxim Munitions Corporation, a Delaware corporation, entered into a contract with the Officine di Villar Perosa, an Italian corporation acting for the Italian government, hereafter referred to as the Italian contract, for the manufacture and delivery of 250,000,000 9-millimeter cartridges. This contract was amended May 31, 1917, and December 14, 1917, the last amendment reducing the quantity of ammunition to be delivered to 125,000,000 cartridges. All of this ammunition was of special design and intended for use by Italy in the war. The Maxim Corporation was required to give bond for the faithful performance of the contract and received from Italy an advanced payment of $1,531,250 for the ammunition to be delivered under the contract. In order to procure the exacted bond the Maxim Corporation deposited with the Maryland Casualty Company, the Fidelity Deposit Company of Maryland, and the United States Fidelity Guaranty Company of the same state, the entire sum so advanced, in such proportions as to secure each of the companies against loss, and later on, when the quantity of cartridges to be delivered was reduced one-half, the surety companies reduced their collateral one-half, and this amount was returned to the Italian corporation and retained by it.

On October 5, 1917, the plaintiff entered into a written contract with the Maxim Corporation, by the terms of which the plaintiff agreed to manufacture and deliver the ammunition in the quantities stipulated and in accord with the terms of the existing contract between the Maxim Corporation and the Italian government. In other words, the plaintiff took over the Maxim contract. The plaintiff acquired materials, manufactured and delivered a large quantity of cartridges, and had on hand materials and undelivered cartridges involved herein, when on November 22, 1918, the Italian authorities canceled the contract of March 19, 1917, between the Maxim Corporation and Italy, and thereafter declined to accept any additional deliveries whatever. Some dispute arose as to the authority of those acting to cancel, an unessential point, but the plaintiff company accepted cancellation as accomplished, and on November 26, 1918, discontinued the manufacture of cartridges entirely. It is conceded by the parties that at the time of the cancellation of the Maxim contract the unworked and finished materials then on hand in plaintiff's plant applicable to the Maxim contract possessed a market value of $79,297.11 and a cost value of $274,659.78. See finding 20. The plaintiff did not realize the cost value of the materials. Following the cancellation of the Maxim contract negotiations ensued for a settlement with the Italian government for the loss occasioned thereby, but neither the plaintiff nor the Maxim Corporation ever obtained any sums in addition to the advance payment made to the Maxim Corporation as heretofore noted. In virtue of waivers filed by the plaintiff, its tax liability, due to audits and examination of its books of account in relation to this particular contract and other transactions to follow, was not finally determined until January 16, 1926, when the Commissioner declined to allow the plaintiff to value its inventory for the year at the market value of the materials on hand to perform its contract with the Maxim Corporation, i.e., $79,297.11, and instead valued its inventory at cost, i.e., $274,659.78.

During the calendar year 1918 the Maxim Munitions Corporation was insolvent, it could not have possibly performed its Italian contract nor pay the plaintiff for its unworked material and finished munitions. It was indebted to the plaintiff in the sum of $300,000, and doubtless, because of its insolvency and indebtedness to the plaintiff, the contract involved herein was made. On May 29, 1919, a petition of involuntary bankruptcy was filed against the Maxim Corporation, and on June 18, 1919, it was adjudicated a bankrupt.

Sec. 203 of the Revenue Act of 1918 ( 40 Stat. 1057, 1060) provides as follows: "That whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income."

Section 234 of the Revenue Act of 1918 ( 40 Stat. 1077) provides in part as follows:

"Sec. 234(a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: * * *

"(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise. * * *"

Article 1584 of Regulations 45, the first regulations promulgated under the act of 1918, reads as follows:

"Art. 1584. Inventories at market. — Under ordinary circumstances `market' means the current bid price prevailing at the date of the inventory for the particular merchandise in the volume in which ordinarily purchased by the taxpayer and is applicable in the cases (a) of goods purchased and on hand, and (b) of basic elements of cost (materials, labor, and burden) in goods in process of manufacture and in finished goods on hand; exclusive, however, of goods on hand or in process of manufacture for delivery upon firm sales contracts at fixed prices entered into before the date of the inventory. * * *"

Articles 1612 and 1614 of Regulations 65, in force in 1926 when the additional taxes now complained of were assessed and paid, read as follows:

"Art. 1612. Valuation of inventories — The act provides two tests to which each inventory must conform: (1) It must conform as nearly as may be to the best accounting practice in the trade or business and (2) it must clearly reflect the income. * * * An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income.

"The basis of valuation most commonly used by business concerns and which meets the requirements of the revenue act is (a) cost or (b) cost or market, whichever is lower. (For inventories by dealers in securities, see article 1615.) Any goods in an inventory which are unsalable at normal prices or unusable in the normal way because of damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes, including secondhand goods taken in exchange, should be valued at bona fide selling prices less cost of selling whether basis (a) or (b) is used, or if such goods consist of raw materials or partly finished goods held for use or consumption, they shall be valued upon a reasonable basis, taking into consideration the usability and the condition of the goods, but in no case shall such value be less than the scrap value. * * *

"Art. 1614. Inventories at market. — Under ordinary circumstances, and for normal goods in an inventory, `market' means the current bid price prevailing at the date of the inventory for the particular merchandise in the volume in which usually purchased by the taxpayer, and is applicable in the cases (a) of goods purchased and on hand, and (b) of basic elements of cost (materials, labor, and burden) in goods in process of manufacture and in finished goods on hand; exclusive, however, of goods on hand or in process of manufacture for delivery upon firm sales contracts (i e., those not legally subject to cancellation by either party) at fixed prices entered into before the date of the inventory, which goods must be inventoried at cost. * * *"

The plaintiff insists that it was entitled under the regulations to value its inventory at cost or market, whichever was lower. The defendant contends that a lawful exception prevails as to this option granted by the regulations in the case "of goods on hand or in process of manufacture for delivery upon firm sales contracts (i.e., those not legally subject to cancellation by either party) at fixed prices entered into before the date of inventory, which goods must be inventoried at cost." The purpose of inventories in a business enterprise such as we have here is apparent, and the Commissioner's regulations as to a valuation of the same on the basis of cost or market value, whichever is lower, were clearly to ascertain accurately annual income in view of fluctuating values of merchandise on hand, at the beginning and close of the year. Mutual Chemical Co. of America, 12 B.T.A. 578. If, however, the taxpayer possesses a contract stipulating a fixed price for the commodity to be manufactured, he is, as pointed out in the opinion just cited, "protected against any reduction in value occasioned by declining market prices." The single exception to the above rule is applicable only to contracts to manufacture and deliver a completed article subject to cancellation by either party. Of course, if a taxpayer is protected against loss of value of unworked materials by the terms of a fixed contract of sale, and obviously such would be the case in firm sales contracts, the valuation of his inventories as related to the contract is not dependable upon cost or market, whichever is lower, and actual income is not to be ascertained by according to inventories the procedure set forth in the regulations where no such condition obtains.

The intent of the regulations, aside from the language used, is manifestly to apply them as the actual situation presents itself to the Commissioner. When the plaintiff's tax liability was finally determined by the Commissioner, it was known to him that the contract between plaintiff and the Maxim Munitions Corporation had been canceled before the expiration of the year 1918. It was also known to him that the Maxim Corporation was insolvent and had been adjudicated a bankrupt, and that plaintiff had not been able to realize cost or anyway near cost for the materials procured by it to perform the Maxim contract. The record further discloses that knowledge of the Italian government's disavowal of any liability under the Maxim contract was brought to his attention, and that hope or prospect of realizing contract prices for munitions under the Italian contract had been foreclosed. The contract between the plaintiff and the Maxim Munitions Corporation contained no cancellation clause applicable to the present contention, but the contract between the Maxim Munitions Corporation and the Italian Corporation, which is the essential subject-matter from which source the plaintiff's income for the term involved was to accrue, did contain a stipulation as follows: "Ninth. Performance. — In the event that the seller shall fail to make deliveries within sixty (60) days after the date or dates upon which such deliveries are due according to the terms of this contract, by reason of fires, strikes, wrecks, explosions, confiscations, eminent domain, the acts of God or the public enemy or for any reason whatsoever, the buyer shall have the right to cancel this contract." Under this clause of the Italian contract the right of cancellation was exercised and liability to the contractor for losses occasioned thereby expressly disavowed by the Italian corporation.

Beyond doubt, default in deliveries obtained. What the plaintiff secured by its contract with the Maxim Munitions Corporation was the right to perform the latter's contract with the Italian corporation — the right, as expressly stated in the contract, "to manufacture cartridges upon the said contracts herein mentioned" — and the contracts identified by "herein mentioned" were the Italian contracts. The situation in which the plaintiff found itself in 1918 was not one where it was in process of performing a firm sales contract; the contract had been suspended, the plaintiff's performance had been effectually foreclosed, and no reason existed to expect that any of the articles contracted for would ever be delivered, the owner of the contract known to be insolvent and no hope of realizing the contract price for delivered articles obtained. If, therefore, the intent of the regulation is to predicate the ascertainment of income, in cases involving a firm sales contract, upon the fact that a valid contract exists whereby the contractor will in due course obtain the contract price, and that the inventory of materials on hand to perform the contract is by reason thereof worth more as a current asset than their market value, then, in so far as the Maxim contract with the plaintiff is concerned, the plaintiff is entitled to value its inventory at market value. It is true that in 1917 the sureties on the bond of the Maxim Munitions Corporation at the request of the corporation loaned the plaintiff $612,500 from the sum deposited with them, i.e., the advance payment made by the Italian government to the corporation which it deposited with the surety companies to go on its bond. This loan made under contracts for repayment, details of which we need not discuss, was in addition secured by the plaintiff's notes for the amount loaned, guaranteed by the National Lead Company (finding 11). The plaintiff has not paid the notes, and suits are now pending against it for their payment and as yet undetermined. The plaintiff on its books of account carries as a liability upon the notes a sufficient reserve to liquidate a possible judgment against it because of this litigation. The defendant asserts that the plaintiff has this sum of money, that it is in excess of the $300,000 which the Maxim Munitions Corporation owes the plaintiff, and also in excess of the total of the former amount and the sum of $274,659.78 valuation put upon the plaintiff's inventory by the Commissioner in 1926, and that, in the event of the plaintiff's successful defense to the pending suits to recover the amount of the loan, the plaintiff will recover more than the contract value of the materials left on its hands by the cancellation of the Maxim contract with Italy. It is also true that the plaintiff purchased on March 16, 1926, for a consideration of $61,250, an unconditional conveyance from the trustees in bankruptcy of the Maxim Munitions Corporation, all the interest of said corporation in and all rights of action it might have against the Italian corporation, and attempts were made to realize from the Italian corporation the loss plaintiff suffered by reason of the cancellation of the Maxim Munitions Corporation contract.

From these facts the defendant argues that the plaintiff has a valid claim for reimbursement of the cost of its inventory. The plaintiff's only possible recourse against the Italian corporation must originate in the purchase of the interests of the Maxim Munitions Corporation against the Italian government. The record discloses that attempts to procure a settlement with the Italian corporation failed, and that the corporation is possessed of no assets in the United States and no known place of conducting business here, where service could be had upon it. In addition to the inferences which may be drawn from the facts as recited, the transactions cited are but remotely related to the issue of the valuation of inventories. Borrowed funds and assigned rights of action under a contract are not directly related to the valuation of inventories; they of course constitute a factor in the ascertainment of income, but their bearing upon the issue in suit is too remote and too conjectural to influence the question of what valuation should be placed under the law and regulations upon the unused and unworked materials allocated to contract work after the contract has been canceled, especially so when the known facts discredit the possibility of realizing from the sources alleged, and a period of eight years having elapsed without any beneficial results. It is impossible now to indicate what may be the outcome of the litigation pending, and whatever it may be the taxing laws take care of it when it becomes a certainty. Lewellyn v. Electric Reduction Co., 275 U.S. 243, 48 S. Ct. 63, 72 L. Ed. 262.

United States Contracts.

The plaintiff entered into four contracts with the United States, represented by the War Department. One of the contracts provided for the manufacture and delivery of 135,100,000 .45-caliber cartridges, and the other three for the manufacture and delivery of 14,760,000 artillery primers. One of the contracts was made in 1917 and all the others on various dates in 1918 prior to November 11, 1918. In each of the contracts there was a provision for their cancellation in the event of the termination of the war, and likewise a provision for settlement of and payment to the plaintiff of amounts due it by reason of cancellation. As to materials on hand at time of cancellation the contracts provided as follows:

"* * * The United States shall also pay to the contractor the cost of the materials and component parts purchased by the contractor for the performance of this contract and then on hand in an amount not exceeding the requirements for the completion of this contract, provided they comply with the specifications, and also all costs shown by the contractor to have been theretofore necessarily incurred in the performance of this contract and remaining unpaid; and the United States shall also protect the contractor on all obligations incurred necessarily and solely for the performance of this contract of which the contractor can not be otherwise relieved. To the above may be added such sums as the Chief of Ordnance may deem necessary to fairly and justly compensate the contractor for work, labor, and service rendered under this contract.

"Title to all such materials and component parts paid for by the United States under this article shall, immediately upon such payment, vest in the United States. * * *"

In December, 1918, following the armistice, the contracts were suspended and the plaintiff duly notified. The plaintiff observed the suspension notice and thereafter, in virtue of settlement contracts, following a somewhat prolonged inspection and audit of plaintiff's accounts, a final settlement was concluded by the terms of which the plaintiff was paid the total sum of $1,154,618.35. Included in the sum so paid is an item of the cost of materials and finished and unfinished articles in plaintiff's plant allocated to the contracts involved, the conceded value of which was $732,088.62. In placing a valuation upon its inventory for the year 1918 the plaintiff claims it is entitled to fix the sum at the market value of the materials, etc., on hand to fulfill the contracts, i.e., the conceded market value of $231,615.43.

The Commissioner of Internal Revenue declined to accede to plaintiff's claim, and instead assessed, levied, and collected from plaintiff income, excess profits, and war profits taxes by valuing plaintiff's inventory for the year 1918 on the basis of the sum paid to it by the United States for materials allocated to the contracts, i.e., $732,088.62. Plaintiff's argument is addressed mostly to the same regulations and sections of the revenue laws that are involved in its contention with reference to inventory values in the preceding Italian contract. The facts as to the United States contracts present a decidedly different situation than was involved in the Italian contract. The United States contracts clearly disclose "firm sales contracts at fixed prices," and, while the contracts were subject to cancellation, they contained express covenants upon the part of the United States to save the plaintiff harmless in so far as the cost of materials, etc., entering into its inventory is concerned. The contracts contained express provisions setting forth with exactness how the plaintiff should be paid, and the items included within the Government's liability to pay. The regulations of the Commissioner, heretofore cited, article 1612 of regulations 65, wherein appears an option to value inventories at cost or market, whichever is lower, must, as we have previously said, be construed in the light of their purpose and in view of an actual and subsisting situation. There can be no doubt that, if the plaintiff's contention is correct, the value it seeks to place upon its inventory for the year 1918 does not represent the actual value received by it for the materials mentioned and does not clearly reflect its income for the year involved.

The Commissioner in determining the plaintiff's tax liability for 1918 had before him the actual situation with respect to plaintiff's status in relation to the United States contracts, and upon the basis of the same determined the tax. The plaintiff does not challenge the correctness of the amounts or dispute the receipt of the sums involved, which necessarily leaves its contention upon the single insistence that the words of the regulations entitle it to recover. Inventories at the beginning and end of the year, as provided for in the regulations, are essential to ascertain income, and, if their valuation may be fixed upon a basis known to be contrary to the actual facts, the purpose of the same is in no sense accomplished. All through the regulations concerned with this subject-matter run numerous provisions designed to meet situations wherein inventories are to be used, which clearly reflect an intent to value the inventories so used upon a basis of fact, and assuredly such a basis may not be challenged as counter to good accounting practice. It is of course true that at the close of the year 1918 the plaintiff was unaware as to the precise sum it would receive in dollars and cents for the materials on hand, the ascertainment of the same was yet to be made, and the final result dependent upon accounting. It did, however, possess an enforceable demand for their cost in the form of a positive covenant to pay the same from a responsible party, and, having voluntarily waived its right to have its tax liability for the year 1918 determined within the period of the statute of limitations with respect thereto, thereby enabled the exact determination of the cost of its inventory free from any uncertainty. The fixed statutory period within which the Commissioner must determine a taxpayer's liability is a period which Congress extended to him to ascertain liability, and the ascertainment of the same is to be accomplished from the taxpayer's return.

We need not recite the details essential to be pursued. It is in this case sufficient to state that an audit of plaintiff's return was available to the Commissioner and actual facts developed from such an audit may not be ignored. Therefore, it seems evident to the court that, so long as the Commissioner was lawfully possessed of the right to determine plaintiff's tax liability for the year 1918, and unquestionably the subject-matter was within his jurisdiction when he did act, he had under the law and regulations the right to take into consideration the fiscal transactions of the plaintiff occurring in that year and the final consummation of the same, notwithstanding it required additional time to ascertain the facts all taking place within the statutory period.

The plaintiff kept its books upon an accrual basis, and when it made its tax returns neither it nor the Commissioner could determine with accuracy its tax liability for the year 1918. The time consumed by both parties was in an effort to fix its taxes for 1918 upon the basis of what the actual value of its inventory should be, and before the statute of limitations expired facts developed which did fix the value of the same in dollars and cents. In this respect the case is no different from the adopted procedure many times occurring with respect to all tax returns involving a similar situation, and to hold that the Commissioner was bound as to the valuation of the inventory given by the taxpayer in the return filed for 1918, when later facts clearly and indisputably show that for all the items involved the taxpayer received cost of the same, would require the court to negative a positive fact. Keeping in mind that action of the Commissioner challenged in this case relates exclusively to plaintiff's tax liability for 1918, and that the Commissioner was acting within the scope of his jurisdiction, we find nothing in the many regulations cited to warrant a contrary holding.

The claims, i.e., the rights conferred upon the plaintiff under the settlement contracts executed by the parties within the year 1918, brought about a situation which within the statutory period matured into an observance of the settlement contracts by the United States and the plaintiff received payment in accord therewith, and all this was part of and essential to the ascertainment of plaintiff's inventory value for the year 1918. An entirely different situation might have developed, a matter not within the purview of the issue in this case, if the settlements had not been accomplished within the statutory period, and payments for the inventory had been postponed to later years. But in such case it would have been the duty of the Commissioner to determine the inventory at the actual cost to the plaintiff. The plaintiff executed the settlement contracts, proceeded thereunder, and received without protest within the statutory period determining its tax liability for 1918 the cost value of its inventory for that year, and while the payment was not made in 1918 it was made to pay for the cost of materials, etc., included in plaintiff's inventory for 1918. In the case of Producers' Fuel Co., 1 B.T.A. 202, the Board of Tax Appeals determined a controversy involving the principle upon which we rely. The Producers' Fuel Company in December, 1920, deliberately breached a contract for the future delivery to it of coal and set up on its books for the year 1920 an estimated liability upon the contract breached. Thereafter in 1921 the company compromised with its contractors for the breach and paid the sum of $35,292.40 in cash. The reserve set up on its books as before noted totaled $37,500, and the company claimed as a deduction this estimated amount from its gross income for the year 1920. The Board of Tax Appeals decided adversely to the plaintiff's contention, and in so doing said: "While it appears that at the end of the year 1920 this taxpayer estimated its liability under the breached contracts with approximate accuracy and set the sum up on its books of account and then made its income and profits tax return in accordance with such books, we have now before us a review of that income and profits tax return and in making such review it is our duty to consider not only the facts known and recorded at the close of December, 1920, but also those same facts as modified by subsequent events. These subsequent events have developed the fact that the damages and losses sustained by the taxpayer on account of the breach of the Monongahela contract were settled for the sum of $5,500, and that the damages and losses sustained by the taxpayer on account of the breach of the Campbell contract were finally determined and settled for the sum of $29,742.40. With these facts before us, and for the purpose of determining the final net taxable income of the taxpayer for the year 1920, the amounts of damages and losses as finally determined must now be substituted for the estimate originally made, and in place of the deductions claimed by the taxpayer in his return and disallowed by the Commissioner the losses and damages as finally settled must be allowed as the deduction contemplated by the law." See, also, cases of McCreery et al., 4 B.T.A. 967, and Ewing Thomas Converting Co. v. McCaughn (C.C.A.) 43 F.2d 503.

Claimed Deduction from Gross Income on Account of the Cost of Buildings Erected on Leased Ground.

Prior to 1914 the plaintiff's factory buildings were rented from the Wamesit Power Company, the business of the plaintiff being carried on at Lowell, Mass., in the rented buildings owned by the Wamesit Company at that place. In 1914, shortly after the World War began, the plaintiff received orders from European governments for ammunition, and, in view of orders in hand and additional ones anticipated, the plaintiff began the erection of buildings essential to its manufacturing needs on land of the Wamesit Power Company at Lowell and South Lowell, Mass. The buildings involved were erected under an agreement between the plaintiff and the Wamesit Power Company that the expense of their construction should be borne by the plaintiff and occupied free of rental by it for a term of ten years, at the expiration of which time they were to become the property of the Wamesit Power Company. Under this agreement, which contained other provisions not material here, the plaintiff erected the buildings involved at a conceded cost of $802,499.49. During the war plaintiff's factory necessities were great and the new buildings erected on the leased grounds were occupied to their capacity. After the close of the war and the suspension of its contracts for ammunition, its business receded to normal conditions, and of course not all of the extra floor space of the buildings involved was needed. The lease under which the buildings were erected did not by its terms expire until the close of 1924, and for the six years remaining, i.e., from 1918 to 1924, the plaintiff occupied the buildings, continuing the manufacture of commercial ammunition and adding to this activity the manufacture of radiators, radiator tubes, phonograph motors, paper boxes, and certain other articles. The plaintiff in its tax return for 1916 charged off as a deduction a very large part of the cost of these buildings and machinery. The Commissioner of Internal Revenue declined to allow the deduction in full, holding that the cost of the plant should be charged off over the ten-year period of the lease, and that only a proportionate part could be charged off each year. The plaintiff acquiesced in the Commissioner's ruling. Later, however, when the war terminated and in making its tax return for 1918, the plaintiff claimed as a deduction from its gross income the depreciated value of the buildings as of December 31, 1917, less their residual value, a total of $414,421.89, this sum being arrived at in the following manner, viz:

Depreciation allowed by the Commissioner for the years 1914 to 1917, inclusive ....... $197,107.74 Cost of buildings ... $802,499.49 Less depreciation ... 197,107.74 ___________ Leaving a depreciated value as of 1918 of ............. 605,391.75 From which a subtraction of residual value ................ 190,969.86 ___________ Leaves ...................... 414,421.89

The Commissioner adhered to his former ruling, disallowed the claimed deductions, and instead allowed a depreciation deduction of $86,484.54, a proportionate annual allowance sufficient in amount to cover the cost of the buildings in the ten-year period of the lease.

The plaintiff's suit contests the ruling of the Commissioner and contends for the deduction claimed in its return for 1918. If the plaintiff's contention is sound, it is entitled to a substantial refund of taxes paid for the year 1918.

Section 234(a) of the Revenue Act of 1918 ( 40 Stat. 1077), in so far as here pertinent, provides as follows:

"Sec. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: * * *

"(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise; * * *

"(7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence. * * *"

Article 143 of regulations 45 as to loss of useful value, is as follows: "Art. 143. Loss of useful value. — When through some change in business conditions the usefulness in the business of some or all of the capital assets is suddenly terminated, so that the taxpayer discontinues the business or discards such assets permanently from use in the business, he may claim as a loss for the year in which he takes such action the difference between the cost or the fair market value as of March 1, 1913, of any asset so discarded (less any depreciation sustained) and its salvage value remaining. This exception to the rule requiring a sale or other disposition of property in order to establish a loss requires proof of some unforeseen cause by reason of which the property must be prematurely discarded, as, for example, where an increase in the cost of or other change in the manufacture of any product makes it necessary to abandon such manufacture, to which special machinery is exclusively devoted, or where new legislation directly or indirectly makes the continued profitable use of the property impossible. This exception does not extend to a case where the useful life of property terminates solely as a result of those gradual processes for which depreciation allowances are authorized. It does not apply to inventories or to other than capital assets. The exception applies to buildings only when they are permanently abandoned or permanently devoted to a radically different use, and to machinery only when its use as such is permanently abandoned. Any loss to be deductible under this exception must be charged off on the books and fully explained in returns of income. But see articles 181-189."

Article 109 of the same regulations, as to rentals, contains the following terms: "Art. 109. Rentals. — Where a leasehold is acquired for business purposes for a specified sum, the purchaser may take as a deduction in his return an aliquot part of such sum each year, based on the number of years the lease has to run. Taxes paid by a tenant to or for a landlord for business property are additional rent and constitute a deductible item to the tenant and taxable income to the landlord, the amount of the tax being deductible by the latter. The cost borne by a lessee in erecting buildings or making permanent improvements on ground of which he is lessee is held to be a capital investment and not deductible as a business expense. In order to return to such taxpayer his investment of capital, an annual deduction may be made from gross income of an amount equal to the total cost of such improvements divided by the number of years remaining of the term of lease, and such deduction shall be in lieu of a deduction for depreciation. If the remainder of the term of lease is greater than the probable life of the buildings erected, or of the improvement made, this deduction shall take the form of an allowance for depreciation. See article 48."

Additional applicable regulations are found in articles 161 and 162 of regulations 45, each of which we quote:

"Art. 161. Depreciation. — A reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used in the trade or business may be deducted from gross income. For convenience such an allowance will usually be referred to as depreciation, excluding from the term any idea of a mere reduction in market value not resulting from exhaustion, wear and tear, or obsolescence. The proper allowance for such depreciation of any property used in the trade or business is that amount which should be set aside for the taxable year in accordance with a consistent plan by which the aggregate of such amounts for the useful life of the property in the business will suffice, with the salvage value, at the end of such useful life to provide in place of the property its cost, or its value, as of March 1, 1913, if acquired by the taxpayer before that date. See further articles 839 and 844.

"Art. 162. Depreciable property. — The necessity for a depreciation allowance arises from the fact that certain property used in the business gradually approaches a point where its usefulness is exhausted. The allowance should be confined to property of this nature. In the case of tangible property, it applies to that which is subject to wear and tear, to decay or decline from natural causes, to exhaustion, and to obsolescence due to the normal progress of the art, as where machinery or other property must be replaced by a new invention, or due to the property becoming inadequate to the growing needs of the business. * * *"

The plaintiff asserts seven distinct reasons, predicated upon facts, relied upon to bring its contention within the revenue laws and the commissioner's regulations. The buildings, it is said, were constructed exclusively for war purposes, there existed no other use for them. The normal business of the plaintiff did not warrant their construction. They were erected on leased premises and their usefulness in any event limited to a ten-year period; they were used up to their capacity for war purposes until 1918. The plaintiff did not know and had no means of knowing when the war would terminate, and hence it was impossible until that date to charge off more than their proportionate cost, as was done. Subsequent to the armistice the plaintiff did not contemplate the manufacture of war munitions for which the buildings had been erected; it received no new orders for war ammunition and of course was not to receive any. Income from rental of the buildings was not available because of a lack of demand for their use; they had been so incorporated into the buildings previously rented from the landlord that they had to be used as a unit unless at great cost they be revamped, which from a financial point of view was not warranted, and finally that the plaintiff sought, by adding to its commercial products the manufacture of a distinct line of articles not theretofore manufactured by it, to obtain a profitable use of the buildings, but without success. In other words, six years in advance of the complete obsoleteness under its lease of the buildings the plaintiff is to be allowed a deduction for the cost of the same, upon the theory that they in 1918 became no longer useful for the precise purposes for which they were erected. It is true the plaintiff made the investment for the purpose of fulfilling war contracts for ammunition, and that the armistice precluded a continuance of their use for this precise purpose, but the physical structures remained upon the premises for at least the full term of its lease; they were used and occupied by the plaintiff during this period largely for the manufacture of ammunition for which use they were adapted; possession was not surrendered to the landlord or the buildings abandoned, and, while unfortunately the continued business enterprise of the plaintiff proved unprofitable, it continued to go forward in these buildings under the same conditions applicable, as shown by the record, to pre-war times. What the plaintiff apparently complains of is not an injustice inflicted upon it by the Commissioner in the amount of the annual or total sums allowed it as depreciation or obsolescence allowances, but that a radical change in business relations and a serious diminution of income in 1918 entitle it to deduct from its gross income for 1918 the total balance of allowances which would accrue annually, less residual value of its lease in the year 1918. Obviously when the war was on, business abnormal and profits correspondingly so, manufacturers built according to their needs, and in many instances at the close of the war were in possession of quarters more than adequate for normal conditions. If, however, as here, the buildings involved were upon leased premises continuously occupied by the tenant for the full term of the lease, they thereby possessed a fixed period of value and usefulness. It is difficult to accurately determine in advance of the expiration of the lease any other loss to the lessee than the annual depreciation or obsolescence of the lease on any other than the basis of a final return of the capital investment. "Obsolescence," as said by the Board of Tax Appeals in the case of Tennessee Fibre Co., 15 B.T.A. 133, "as used in the statute is the state or process of becoming obsolete and the provision allowing a deduction therefor is intended to care for losses of capital which take place over a longer period than the taxable year." We are not confronted by the record with the happening of some event which rendered the buildings obsolete prior to the expiration of the lease, where the allowance of annual depreciation proportionate to their cost is insufficient to return cost of the same, for the buildings were not abandoned nor unsuitable for plaintiff's continued activities. Plaintiff may not have had use for all the floor space within them as it did previously, but this is not attributable to the buildings, it is due wholly to a loss of income from business activities. The economic condition which affected plaintiff was almost wholly due to loss of volume of business and not its character. No single factor of the situation rendered the buildings obsolete in 1918, nor at any time thereafter until the expiration of the lease. Depreciation allowances under these circumstances comply with the revenue laws and regulations. In the recent case of Atwater Co., Inc., 22 B.T.A. ___, the opinion deals with an issue similar to the instant case. From the opinion we cite the following excerpts:

"The petitioner claims in the alternative that it is entitled to a deduction for the obsolescence of the discharging tower completed in February, 1919. This claim is made on the unique theory that obsolescence exists in a case `where the property turned out to be more than adequate for the needs of the business and it is foreseen that its value to the, taxpayer is less than the balance of the cost less ordinary depreciation resulting from wear and tear spread over the actual physical life of the property.' * * *

"In the case at bar the element of obsolescence was not shown to have been present. We assume that the usual allowances were made for depreciation, wear and tear. No new or more modern machinery was being invented or used to replace its equipment. Only the ordinary repairs were necessary to insure its continued use as a modern and up-to-date facility such as would conform to the petitioner's present and future needs. Though the additional tower may have given petitioner an excess capacity, this fact does not establish obsolescence. We are of the opinion that petitioner is entitled to no deduction on the ground of obsolescence."

The Board of Tax Appeals in the case of Marigold Garden Co. v. Commissioner, 6 B.T.A. 368, 370, in discussing the principle involved in this case, said: "Uselessness to a taxpayer does not determine a deductible loss any more when attributable to a statutory prohibition than when attributable to any other extraneous cause over which the owner has no control. A change in style or market, or an exhaustion of the supply of raw materials for manufacture may destroy the utility of equipment just as effectually as the intervention of the law, and the detriment to the owner may be just as great. It seems clear that property is not ipso facto lost to a taxpayer because it is no longer useful to him. Ownership and possession still exist, and in some cases value may not wholly disappear. Value and usefulness are not necessarily interdependent, even though they very commonly look to each other for support. The want of either does not make certain the absence of the other. It should be kept in mind that the considerations in ascertaining net income must always be expressed in money and that all the factors relied upon must be translated into terms of money. Use is only significant to the extent that it is susceptible of such expression. No one would urge that an income deduction may be claimed because a fixture or tool proves less useful than expected when the purchase was made. Until the investment is converted into terms of money by sale or other disposition or its worthlessness otherwise demonstrated, there is neither loss nor gain and income is neither greater nor less."

The case of the McCabe Lathe Machinery Co., 9 B.T.A. 1137, 1143, decided in 1928, involved in part an issue similar to plaintiff's contention. In deciding the case the Board in its opinion said: "The mere fact that a building is used for a purpose different than that originally intended does not determine the building to be obsolete. The loss which will be sustained over the remainder of the lease, after allowing for exhaustion of the cost of the building, is deductible yearly and can not be anticipated upon the theory that obsolescence has taken place when, in fact, the building continues to be suitable for the purpose of its erection and all that has taken place is a reduction in its income-producing capacity. The determination of the Commissioner as to this issue is, therefore, sustained." See, also, Troy Mfg. Co. Case, 7 B.T.A. 119; National City Bank of Seattle v. United States, 64 Ct. Cl. 236; Id., 276 U.S. 620, 48 S. Ct. 301, 72 L. Ed. 735.

We think a decided difference obtains between this case and the case of Burnet v. Niagara Falls Brewing Co., decided by the Supreme Court February 24, 1931, 282 U.S. 648, 51 S. Ct. 262, 264, 75 L. Ed. ___. The present record presents, in our opinion, a case where the plaintiff occupies buildings upon leased premises, buildings which possess a useful life in excess of the life of the lease, but which, in so far as the plaintiff is concerned, become obsolete upon a date certain, and the Commissioner possessed of this information determines obsolescence upon a basis which in accord with facts returns to the plaintiff the cost of the same. It is in all respects similar to a case wherein a business enterprise enjoying prosperity finds enlarged quarters essential to meet its demands, and without knowledge as to any exact date when an intervening incident may curtail its income, such as bad times, termination of a war, drought, etc., income is materially reduced or disappears, and the enlarged quarters are no longer essential for the needs of the corporation during this period of distress. Under these circumstances what may happen to the buildings during the remaining period of the lease is problematical and is distinctly different from a case where legislation prohibits the future use of the buildings for the purposes erected, and for which purpose they were specially designed and constructed and not "readily adaptable to other uses." The Commissioner in the present case did not refuse an obsolescence allowance. On the contrary, as previously observed, the plaintiff obtains a return of its capital investment; the only issue in the present case is as to the year in which the deduction of obsolescence of tangible property should be allowed. In the Niagara Case, supra, the Supreme Court said: "Clearly the statute contemplates that, where warranted by the facts, the taxpayer shall have the benefit of, and in making his return may deduct in each year, a reasonable allowance to cover obsolescence of the tangible property," a holding in response to a contention upon the part of the United States that the statute did not authorize obsolescence allowance of tangible property in the familiar and so-called prohibition cases, an issue foreign to the record in this case. What the plaintiff is asking here is an anticipation of obsoleteness without a record to support the contention.

Finding 56 discloses the facts with reference to the plaintiff's claim of loss of useful value for a garage erected upon leased premises. We think the facts as found and not disputed bring the claim within what we have said with reference to the factory buildings. The findings clearly show that the claim may not be sustained.

We think that under the Italian contract the plaintiff is entitled to recover and will enter judgment therefor when the amount of the same is determined. As to the remaining items of the case the court concludes that they are without merit, and no allowance will be made therefor. It is so ordered.

WHALEY, Judge, took no part in the decision of this case.