Opinion
Docket No. 56691.
1959-04-22
JOHN ERNST AND MARGARET ERNST, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Kenneth W. Bergen, Esq., for the petitioners. James E. Markham, Jr., Esq., for the respondent.
Kenneth W. Bergen, Esq., for the petitioners. James E. Markham, Jr., Esq., for the respondent.
Petitioner, a poultry farmer, made substantial payments in December of each of the taxable years to a grain dealer which thereby became obligated to deliver to petitioner during the succeeding months according to his normal needs the quantities of the specified feeds which the amounts received would pay for at the prices effective on the dates of delivery. In all years subsequent to the taxable years petitioner made similar payments in December but took delivery in that month of the feed paid for. Petitioner had no right to a return of any of the payments made. Held, such payments are deductible in the years of payment. R. D. Cravens, 30 T.C. 903, distinguished.
The Commissioner determined deficiencies in Federal income taxes of petitioners, John and Margaret Ernst, for the taxable years 1948 and 1949 in the respective amounts of $24,469.50 and $53,659.10.
The deficiency for 1948 results in greater part from respondent's determination that petitioners, who operated a poultry farm, were not entitled to deduct in that year $20,532.50 paid in that year for chicken feed which was not delivered until the next year. The deficiency for 1949 results from respondent's determination that petitioners were not entitled to deduct in 1949 similar payments in the total amount of $110,330 made in that year for chicken feed not delivered until the following year.
The issue presented for decision in this case is whether those payments in 1948 and 1949 were ‘expenses pad or incurred’ in those years so as to be allowable deductions in the computation of net income for those years under sections 23(a)(1)(A) and 43 of the Internal Revenue Code of 1939. Respondent has determined that such payments were advances on executory or contingent contracts for the future delivery of such feed ‘and as such would not be deductible until the year in which the sale(s) (were) actually consummated.’
FINDINGS OF FACT.
Most of the relevant facts were the subject of a stipulation by the parties. All facts so stipulated and the exhibits attached thereto are made a part of our findings by this reference.
Petitioners John and Margaret Ernst, husband and wife, are residents of the vicinity of Augusta, Maine, where at all times pertinent hereto they owned and operated a poultry farm. They filed joint income tax returns for the taxable years with the then collector of internal revenue for the district of Maine, using Form 1040 F, ‘Schedule of Farm Income and Expenses,‘ to report the income from their farm. John Ernst, hereinafter sometimes referred to as petitioner, used the cash receipts and disbursements basis in keeping his books and in reporting income and expenditures for income tax purposes.
During 1948 and 1949 petitioner purchased feed for the chickens on his farm exclusively from Merrill & Mayo, Inc., a grain dealer in Waterville, Maine. Cunningham Grain Company is a corporation which owns and operates feed supply stores in Maine, one of which is called for business purposes Merrill & Mayo, Inc., hereinafter referred to as ‘Merrill & Mayo.’ (Merrill & Mayo will be discussed as the seller of feed and grain to petitioner although transactions were cleared, reported, recorded, and approved by the parent, Cunningham Grain Company, Malden, Massachusetts.) Merrill & Mayo used an accrual method of accounting during the period pertinent to this case.
Petitioner obtained baby chicks each year from the latter part of January to the early part of May and raised them on his farm. The female chicks earliest purchased each year commenced laying at some time in August when they attained an age entitling them to be known as pullets. The egg production of petitioner's poultry farm reached its peak during November and December when the pullets were of the age of 7 to 10 months. These pullets produced fewer eggs after December and during the winter months. Their egg production decreased to the extent of 5 to 10 per cent during the cold Maine winters. November and December were petitioner's best income-producing months, with the rate of egg production at a peak and the seasonal price of eggs at its highest. His income was lower in the first part of a calendar year because the older pullets produced fewer eggs on account of the cold weather and the newly acquired pullets had not commenced laying. Petitioner fed approximately $20,000 worth of feed per month in the operation of his poultry farm during the years relevant hereto.
On December 18, 1948, petitioner made a payment of $20,532.50 to Merrill & Mayo, and received an invoice dated December 21, 1948. This invoice reads as follows:
+------------------------------------------------------------------+ ¦John Ernst ¦$20,532.50 ¦ +------------------------------------------------------------------¦ ¦This represents a purchase of 8 cars of trademarked feeds price to¦ +------------------------------------------------------------------¦ ¦be adjusted date of shipment. ¦ ¦ +------------------------------------------------------------------+
It was the understanding between petitioner and Merrill & Mayo that petitioner would be entitled to a quantity of laying mash called trademarked feeds, at the rate of petitioner's normal usage, to be measured at the time delivery was requested by petitioner by the price of the laying mash at that time on the weekly wholesale price list published by Merrill & Mayo. The figure $20,532.50 was reached by ascertaining the price, as of December 21, 1948, of 8 carloads of laying mash on the weekly wholesale price list. There was no provision for refund of any part of the $20,532.50 paid to Merrill & Mayo.
In order to make this payment, petitioner obtained funds from the Federal Trust Company, Waterville, Maine, by means of a loan, bearing interest and secured by the pledge of savings certificates of that bank. The withdrawal in December of deposits represented by those certificates would have caused the loss of a large part of the semiannual interest payment for January on those deposits. It was to petitioner's financial benefit to pay the Federal Trust Company interest upon a loan in the amount of his advance payment to Merrill & Mayo and collect his semiannual interest payment in January from that bank rather than forfeit his right in January to accrued interest by withdrawing his savings.
The feed requirements of petitioner's farm in December 1948 were not such that a delivery of the 8 carloads or any part thereof in that month was necessary. Petitioner's credit rating was excellent, and there was no shortage of feed during the years relevant herein. Deliveries of $20,532.50 worth of feed were made to petitioner in January, February, and March 1949 and were completed by March 7, 1949. Petitioner paid no insurance on any amount of feed held by Merrill & Mayo or by Cunningham Grain Company and paid no storage or warehouse fees to either company at any time relevant hereto. Merrill & Mayo credited the payment of December 18, 1948, to petitioner's account-receivable card. Charges thereto were made by Merrill & Mayo at the time deliveries of feed were made to petitioner in January, February, and March 1949, in amounts determined by the size of deliveries as requested by petitioner and by the prevailing price at the time of deliveries.
During December 1949 petitioner made advance payments to Merrill & Mayo upon invoices, the dates, terms, and prices reading as follows:
+-----------------------------------------------------------------------------+ ¦Date of payment ¦Terms ¦Amount ¦ +-----------------+--------------------------------------------------+--------¦ ¦ ¦This represents a purchase of 32 cars of feed and ¦ ¦ ¦12/15/49 ¦322 bags of scratch price to be adjusted date of ¦$80,000 ¦ ¦ ¦shipment. ¦ ¦ +-----------------+--------------------------------------------------+--------¦ ¦12/27/49 ¦This represents purchase of 4500 bags scratch ¦$15,165 ¦ ¦ ¦price to be adjusted date of shipment. ¦ ¦ +-----------------+--------------------------------------------------+--------¦ ¦12/29/49 ¦In payment of 4500 bags of scratch price to be ¦$15,165 ¦ ¦ ¦adjusted date of shipment. ¦ ¦ +-----------------------------------------------------------------------------+
The understanding, regarding quantity and price upon delivery, of petitioner and Merrill & Mayo as to these agreements was the same as that which surrounded the transaction of December 1948. The receipts from Merrill & Mayo to petitioner, evidencing these agreements, read as follows:
1. 12-15-49 Rec'd from John Ernst $80,000.00 in payment for the following feed.
+----------------------------------+ ¦322 bags Scratch ¦$1,088.00 ¦ +-----------------------+----------¦ ¦14,400 Laying Mash 4.04¦58,176.00 ¦ +-----------------------+----------¦ ¦4,800 Breeder Mash 4.32¦20,736.00 ¦ +-----------------------+----------¦ ¦ ¦$80,000.00¦ +----------------------------------+
MERRILL & MAYO, INC.
/s/ G.E.Ryan
2. Dec. 27, 1949. Received of John Ernst $15,165.00 for 4500 bags Scratch at 3.37 per bag.
MERRILL & MAYO, INC.
/s/ L. L.
3. Dec. 29, 1949. Recd from John Ernst $15,165.00 in payment for 4500 bags Scratch at 3.37.
MERRILL & MAYO, INC.
Waterville, Me.
/s/ G. Ryan
There was no contractual provision for the refund of any payment or part thereof. Petitioner again borrowed money from the Federal Trust Company, Waterville, Maine, upon his savings certificates for the same reason that he had done so in December 1948. He had no immediate need for the quantities of feed paid for in December 1949. It was agreed that he would take deliveries according to his normal usage after January 1, 1950. Such deliveries were made in January, February, March, April, May, June, and July 1950. The Merrill & Mayo store in Waterville, Maine, did not have adequate supplies on hand to make immediate delivery of the specified feed as of the dates of payment in December 1948 or December 1949, but it could have obtained the feed from Cunningham Grain Company at those times if petitioner had requested it. The last delivery of feed under the transactions of December 1949 was made in July 1950; $110,330 worth of feed had been delivered under those agreements. No insurance or storage was paid by petitioner upon feed held by Merrill & Mayo.
Merrill & Mayo credited payments made by petitioner to his account-receivable card and charges were made at the time of deliveries as requested by petitioner. These charges were determined by the quantity of the deliveries and the prevailing price on the weekly wholesale price list at that time.
Neither a sale nor sales income was taken into account on the books of Merrill & Mayo until the time of the delivery of the feed to petitioner.
Grain was inventoried by Merrill & Mayo without adjustment for any amount covered by the payments received from petitioner until delivery.
Petitioner did not insure the amount of grain covered by the payments before delivery of the grain. Warehouse charges were not made by the supplier for storage of the undelivered grain.
Merrill & Mayo did not request that petitioner initiate any of the transactions hereinbefore set forth.
Petitioner, at all times relevant hereto, and adequate storage facilities to store the feed paid for in 1948 and 1949. In all years subsequent to the taxable years petitioner paid in December for feed to be used in the spring months of the following year, but took delivery at the time of payment and stored the feed on his own premises. The amounts of the purchases made by petitioner in December of the subsequent years were equal to the amounts of the purchases made in December 1949.
Petitioner agreed to and did make the payments in December 1948 and December 1949, and Merrill & Mayo agreed to make deliveries of the specified kinds and types of feed as ordered by petitioner according to his normal usage after January 1, 1949, and January 1, 1950.
OPINION.
KERN, Judge:
In the instant case, the payments for feed disallowed by respondent were not in the nature of deposits to be reimbursed to petitioner if he decided not to order delivery of the feed or if the grain dealer would not or could not make such delivery. The payments were absolute and petitioner, who reported his income on a cash receipts and disbursements basis, was irretrievably out of pocket the amounts paid, which amounts were obviously expenses incident to ‘carrying on a trade or business.’ In return for these payments, the grain dealer was unconditionally obligated to deliver to petitioner the quantity of feed which the amounts received would pay for at the prices in effect on the dates of delivery. There was no condition as to the obligation itself; the only condition was as to the quantum of the obligation. Similar payments for feed to be used in the spring months of the following year were made by petitioner in December of all years subsequent to the taxable years.
This practice does not substantiate the statements of counsel for respondent that ‘(t)hese transactions have no commercial meaning or sense other than as a tax dodge’ and ‘that to allow such deductions would materially distort petitioner's income.’ Indeed, counsel for respondent frankly conceded that although the amounts disallowed in each of the taxable years had not been allowed in any other year, some such adjustments would have to be made in 1949 and the subsequent year in order to prevent the respondent's own action from distorting petitioner's income.
In the subsequent years petitioner, at the suggestion of the local revenue agent, took delivery of the feed needed for the spring months in December (when the payments were made) and stored it on his own premises.
These circumstances distinguish the instant case from R. D. Cravens, 30 T.C. 903.
Regardless of whether taxpayers are on a cash or accrual basis, the general rule is that deductions are allowable in the year of payment.
On the record before us, we conclude that the payments here involved were ‘ordinary and necessary expenses paid or incurred during the taxable year(s) in carrying on (a) trade or business' and were properly deductible by petitioner in the years of payment under section 23(a)(1)(A) of the Internal Revenue Code of 1939.
We need not go into the question of whether or not the payments here involved constituted income to the grain dealer in the years when they were received. Cf. Veenstra & DeHaan Coal Co., 11 T.C. 964. The manner in which the grain dealer treated these payments taxwise is not relevant to a determination of petitioners' tax liability. Citizens Federal Savings & Loan Assn. of Covington, 30 T.C. 285, 292.
In our opinion the allowance of the deductions taken by petitioner in the taxable years would more clearly reflect his income than their disallowance, and no provision of section 43 of the Internal Revenue Code of 1939
justifies respondent in disallowing such deductions.
SEC. 43. PERIOD FOR WHICH DEDUCTIONS AND CREDITS TAKEN.The deductions and credits (other than the corporation dividends paid credit provided in section 27) provided for in this chapter shall be taken for the taxable year in which ‘paid or accrued’ or ‘paid or incurred’, dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions or credits should be taken as of a different period. In the case of the death of a taxpayer whose net income is computed upon the basis of the accrual method of accounting, amounts (except amounts includible in computing a partner's net income under section 182) accrued as deductions and credits only by reason of the death of the taxpayer shall not be allowed in computing net income for the period in which falls the date of the taxpayer's death.
Decision will be entered under Rule 50.