Opinion
Docket No. 15596.
1952-01-2
PACIFIC GRAPE PRODUCTS CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Samuel Taylor, Esq., and Walter G. Schwartz, Esq., for the petitioner. Robert G. Harless, Esq., for the respondent.
1. Petitioner, a canner of fruit products, reported its income on a calendar year accrual basis. On December 31 of each of the years 1939, 1940, and 1941, it had billed buyers for goods on hand which it had in those years contracted to sell but for which the buyers had not yet issued shipping instructions; however, the goods were not labeled, cased, shipped out, or paid for until later taxable periods. When it billed the goods the petitioner recorded on its books as of the same dates sales of these products and recorded also the accrual of both the expense of brokerage fees incurred with respect to the sale of these goods and the estimated expenses of labeling, casing and freight, all of which it was contractually liable to perform. In the year 1944 petitioner sold to the United States Government certain goods not yet cased. These goods were cased in 1945 prior to shipment. Held, that title to the unshipped and unpaid for goods did not pass to the petitioner's buyers on the billing dates because the goods subject to the contract were not then ascertained. Accordingly, petitioner erroneously accrued income from the sale of these unshipped goods in the taxable years when it billed its buyers therefor. Held, further, that petitioner is not entitled to a deduction for the accrued brokerage fees in the years in which the unshipped goods were billed for lack of proof as to when its liability to pay such fees became fixed. Held, further, that petitioner's liability with respect to expenses for labeling, packing, freight, and the like did not become fixed until such services were performed and, accordingly, estimates of such expenses are not deductible in prior taxable years when the petitioner undertook the contractual obligation to perform such services.
2. On the basis of the facts presented, held, that the salaries and traveling expenses of an executive assistant to the petitioner's president and of regularly employed chemists, as well as various costs incurred with respect to work performed by the chemists, were ordinary and necessary business expenses deductible under section 23(a) of the Internal Revenue Code. Samuel Taylor, Esq., and Walter G. Schwartz, Esq., for the petitioner. Robert G. Harless, Esq., for the respondent.
Respondent determined deficiencies in income taxes, declared value excess-profits taxes and excess profits taxes against the petitioner as follows:
+----------------------------------------+ ¦ ¦ ¦Declared ¦ ¦ +----+----------+---------+--------------¦ ¦ ¦ ¦value ¦ ¦ +----+----------+---------+--------------¦ ¦Year¦Income tax¦excess ¦Excess profits¦ +----+----------+---------+--------------¦ ¦ ¦ ¦profits ¦tax ¦ +----+----------+---------+--------------¦ ¦ ¦ ¦Tax ¦ ¦ +----+----------+---------+--------------¦ ¦1940¦$12,298.07¦ ¦$2,055.35 ¦ +----+----------+---------+--------------¦ ¦1941¦ ¦ ¦4,401.88 ¦ +----+----------+---------+--------------¦ ¦1942¦ ¦ ¦59,254.23 ¦ +----+----------+---------+--------------¦ ¦1943¦12,686.64 ¦ ¦ ¦ +----+----------+---------+--------------¦ ¦1944¦ ¦$1,989.76¦38,868.59 ¦ +----------------------------------------+
The petitioner claims an overpayment of its excess profits tax for the taxable year 1941 in the amount of $19,620.01 and for the year 1944 in the amount of $1,689.77. In his answer to the amended petition, the respondent asserted a claim for an additional deficiency in excess profits tax for 1941 in the amount of $3,865.90. Of the adjustments made by the respondent in determining the above deficiencies, those contested by the petitioner result in the presentation of the following questions for decision:
(1) Did petitioner erroneously report accrued income from sales of certain unshipped and unpaid goods in the taxable years in which it billed its buyers for such goods?
(2) In each of the taxable years in which petitioner treated the unshipped but billed goods as sold, was it entitled to take a deduction for accrued brokerage fees incurred in connection with the sale of such goods?
(3) Was petitioner entitled to accrue estimated costs of freight and other expenses relative to the preparation of its products for shipment in the taxable periods in which it undertook a contractual liability to perform the services where such preparation and shipment of the goods took place, and the liability for the costs thereof was established, in subsequent taxable periods?
(4) Are salaries of chemists and other expenses in connection with their laboratory and analytical work on food products and the salary and traveling expenses of an executive assistant to petitioner's president ordinary and necessary business expenses of petitioner deductible under section 23(a) of the Code?
FINDINGS OF FACT.
Part of the facts were stipulated and we find them as stipulated.
Petitioner, a corporation organized and existing under the laws of the State of California, has its principal office at Modesto, California. It duly filed its corporate income and declared value excess-profits tax returns for the years 1939 to 1945, inclusive, and its excess profits tax returns for the years 1940 to 1945, inclusive, with the collector of internal revenue for the first district of California.
Petitioner has at all times since its incorporation in 1926 kept its books and filed its tax returns on a calendar year accrual basis.
Petitioner is a canner of fruit and fruit products. Its yearly canning season usually covers a period from July 1 to the following November. It currently disposes of its products by sales to wholesalers. These sales are usually made through brokers. Some of the contracts are entered into prior to, and others after, the completion of the canning season. In contracting for the sale of its current pack of fruit products for each of the years 1939, 1940, and 1941, petitioner, following its regularly established practice, employed a standard form of contract known as the Pacific Coast F.O.B. Canned Foods Contract. This contract has been in general use by a predominant number of members of the canning industry in California since about the year 1922. On the face of the contract are printed terms of purchase and sale, stating that ‘* * * buyer has this day bought and * * * seller has this day sold ‘ certain canned foods. Spaces are provided for the indication of the quantity, brand, grade, varieties, and price of the canned products. Additional terms and conditions are contained on the reverse side of the contract and they read in part as follows:
TERMS: Cash less two per cent (2%) if draft, with documents attached, payable in New York, Chicago, or San Francisco exchange, or equivalent, is paid within ten (10) days from date thereof; otherwise less on per cent (1%) in thirty days unless shipment arrives prior thereto, in which case payment less one per cent (1%) in thirty days unless shipment arrives prior thereto, in which case payment less one per cent (1%) shall be made within three (3) full business days after arrival of shipment. Draft shall not be dated earlier than date of bill of lading and instructions to collecting bank shall provide that if draft arrives on the tenth day or thereafter twenty-four hours grace shall be given after presentation. Documents against payment. If during the life of his agreement the financial responsibility of the buyer becomes impaired, or payments from buyer are past due, cash payment in advance with regular discount may be demanded by seller before further shipments are made.
DELIVERIES: F.O.B. Pacific Coast rail shipping point. Local freight and transfer charges from interior points to port of shipment to be paid by buyer. All local freight, cartage and handling charges for assembling purposes incurred on less than carload lots to be paid by buyer.
SHIPMENT AND STORAGE: On account of shipment from different factories, seller reserves the routing of freight. Notwithstanding shipped to seller's order, goods are at risk of buyer from and after delivery to carrier, and buyer hereby assumes all responsibility for shortage, loss, delay, or damage in transit upon issuance to seller by carrier of clean bill of lading.
It is specifically agreed that any route herein specified shall be subject to its being open or available at time of shipment. If, after notice by seller, where seller elects to give such notice, buyer does not desire to have shipment made by some route then open or available, seller may store and insure goods for buyer's account. If so stored and insured, buyer agrees to pay draft with documents, less two per cent (2%) in New York, Chicago, or San Francisco exchange or equivalent, within ten days from date of draft. Draft shall not be dated earlier than date of warehouse receipt and instructions to collecting bank shall provide that if draft arrives on the tenth day or thereafter twenty-four hours grace shall be given after presentation.
Goods to be shipped in (at) seller's discretion as soon as practicable after packing. Any difference in freight and terminal charges on account of seller shipping in more than one carload to be paid by seller. Seller reserves the right to ship goods unlabeled when delay in receiving buyer's labels holds back shipment. If seller shall elect to withhold shipment at buyer's request, then the goods unshipped shall be billed and paid for on the following dates, respectively, hereinafter specified.
PEAS AND SPINACH, July 1st; ASPARAGUS, August 1st; TOMATOES OR TOMATO PRODUCTS, November 1st; FRUITS, FRUIT PRODUCTS OR SUNDRY VEGETABLES, December 31.
Buyer agrees to pay for unshipped goods in ten days from the date of draft, less cash discount of two per cent (2%), with warehouse receipt attached. Draft shall not be dated earlier than date of warehouse receipt and instructions to collecting bank shall provide that if draft arrives on the tenth day or thereafter twenty-four hours grace shall be given after presentation. Seller agrees to store said goods and to insure them for buyer's account in a company or companies licensed by the Insurance Commission of California, against loss or damage by fire. Buyer shall pay one and one-half cents (1 1/2 cents) per case per month to cover cost of both storage and insurance, fractions of months at full monthly rate and charges shall accrue from date of warehouse, or storage receipt to date of shipment. Seller shall have the right to move and store said goods at buyer's expense in public warehouse, if goods are not ordered out by buyer prior to March 1st following date of billing as above. Buyer shall reimburse seller for local taxes assessed the first Monday in March, seller to declare quantity and valuation for buyer's account.
In 1939, 1940, and 1941 petitioner contracted for the sale of its goods on the standard contract form and employed the services of brokers in selling its goods in accordance with its usual method of transacting its business. All of these contracts were entered into and were later performed in the State of California.
On December 31 of each of the years 1939, 1940, and 1941 petitioner billed its buyers for that quantity of the goods which was subject to outstanding contracts and which had not yet been ordered shipped by the buyers. When it made these billings petitioner had on hand sufficient goods of the various grades, varieties, and sizes of cans to fulfill all obligations under the outstanding contracts; however, it had not yet labeled or cased these goods.
In accordance with its regularly established method of procedure petitioner billed its buyers for the unshipped goods in several ways. To some of its customers it merely sent an invoice (sometimes referred to as open billing or billing on account). In other instances petitioner forwarded with the invoice a draft for the amount of the purchase price. Where a buyer who was billed by draft so requested, petitioner procured for that buyer a warehouse receipt. Such warehouse receipts were issued by the warehouse company which leased petitioner's warehouses and operated them as bonded warehouses. The type of warehouse receipt issued listed the quantity, variety, grade, and can size of every item billed, together with the location in the warehouse of each such item, and they stated that the goods covered thereby were held for the account of the buyer and were to be delivered upon the written order of the buyer. The quantity, if any, of the unshipped goods for which such warehouse receipts were provided in the years in question is unknown.
It is customary among members of the California canning industry t bill their buyers sometimes on open account, sometimes with draft attached, and sometimes with draft and warehouse receipt attached with respect to goods sold under the Pacific Coast F.O.B. Canned Foods Contract.
With respect to the unshipped goods billed to buyers on open account petitioner made entries on its books on the billing dates, December 31, 1939, 1940, and 1941, respectively, whereby it charged the account, accounts receivable-open account, and credited the sales account with the sales price of the goods. It charged its cost of goods sold account and credited an account, reserve for inventory, with the cost of the unshipped goods. With respect to the goods billed in 1940 and 1941 with drafts attached, petitioner charged the account, drafts receivable, and credited the sales account with the amount of the sales price and charged its cost of goods sold account and credited its inventory account with the cost of the unshipped goods.
On the dates the unshipped goods were billed petitioner remained liable under its contracts with its customers to label and case the goods and, in some instances, to pay certain freight costs. Accordingly, on the same dates it charged the account, shipping expense, and credited the account, reserve for shipping expense, with the estimated cost of labels, cases, warehouse labor, freight and supplies incident to shipping the goods. It also charged its brokerage account and credited the accrued brokerage account with the total amount of the brokerage fees applicable to the sales of the unshipped goods.
In the year following each December 31 billing date, various buyers sent to petitioner shipping instructions regarding the unshipped goods billed to them on December 31 and petitioner shipped such goods accordingly. Buyers billed with drafts attached were not rebilled for such goods, and petitioner made no entries in its books as to such goods at the time of such shipments except to charge the account, reserve for shipping expense, and credit the account, shipping expense, for the shipping expenses applicable to such shipments. In some cases buyers billed on open account were not rebilled and petitioner made no entries on its books at the time of such shipments except to charge the account, reserve for inventory, and credit the inventory account for the goods thus shipped, and to charge the account, reserve for shipping expense, and credit the account, shipping expense, for the shipping expenses applicable to such shipments. In other cases, buyers billed on open account were rebilled with drafts attached to such billings at the time of shipment. In such rebilling petitioner recorded the transaction by two entries on its books, first, it charged the account, drafts receivable, and credited the sales account with the price of the goods rebilled and then charged the sales account and credited the account, accounts receivable-open account, with the same amount.
The entries made by the petitioner on its books with respect to the unshipped goods which were billed to buyers on December 31, 1939, 1940, and 1941, respectively, indicate that sales of such goods were recorded on the books on the billing dates.
On its tax returns petitioner reported accrued income from the sales of unshipped goods for the taxable years 1939, 1940, and 1941, respectively, when the goods were billed to the buyers by including in reported sales the sales price of the unshipped goods and by correspondingly reducing the inventories. It also took deductions in these years for the accrued brokerage and shipping expenses.
It was the common understanding of the members of the California canning industry that where the standard contract form was employed title to the unshipped goods passed on the billing dates, regardless of the method employed in billing. The standard accounting procedure employed by the canning industry was to record on such billing dates sales of the unshipped goods and also the amount of unpaid brokerage fees applicable to such sales, as well as the estimated cost of shipping the goods.
In the year 1944 petitioner sold fruit products to the United States Government. Some of these sales were made directly to the Government and others were made through the Kadota Fig Association. Such contracts provided for delivery in 1945. As in the case of goods billed to its regular customers, petitioner accrued on its books in the year 1944, when the sales were made, the estimated expenses of crating the canned goods sold to the Government and this crating took place in 1945. In its corporate and declared value excess-profits tax return for the year 1944, petitioner took a deduction for the estimated cost of such crating.
The following expenses were incurred by the petitioner in the taxable year 1945:
+---------------------------------------------------------------------+ ¦William B Hanel—chemist ¦ ¦ ¦ +-------------------------------------------------+---------+---------¦ ¦Salary ¦$1,600.00¦ ¦ +-------------------------------------------------+---------+---------¦ ¦Traveling expense ¦429.37 ¦ ¦ +-------------------------------------------------+---------+---------¦ ¦ ¦ ¦$2,029.37¦ +-------------------------------------------------+---------+---------¦ ¦Floyd Munson—chemist ¦ ¦ ¦ +-------------------------------------------------+---------+---------¦ ¦Salary ¦1,800.00 ¦ ¦ +-------------------------------------------------+---------+---------¦ ¦Traveling expense ¦211.71 ¦ ¦ +-------------------------------------------------+---------+---------¦ ¦ ¦ ¦2,011.71 ¦ +-------------------------------------------------+---------+---------¦ ¦C. A. Rodegerdts—executive assistant to president¦ ¦ ¦ +-------------------------------------------------+---------+---------¦ ¦Salary ¦3,018.75 ¦ ¦ +-------------------------------------------------+---------+---------¦ ¦Traveling expense ¦113.66 ¦ ¦ +-------------------------------------------------+---------+---------¦ ¦ ¦ ¦3,132.41 ¦ +-------------------------------------------------+---------+---------¦ ¦Laboratory supplies & expense ¦ ¦534.87 ¦ +-------------------------------------------------+---------+---------¦ ¦Rental on cold storage space ¦ ¦435.11 ¦ +-------------------------------------------------+---------+---------¦ ¦Raw products, cans, plant labor ¦ ¦441.70 ¦ +-------------------------------------------------+---------+---------¦ ¦Miscellaneous expenditures ¦ ¦70.00 ¦ +-------------------------------------------------+---------+---------¦ ¦Total ¦ ¦$8,655.17¦ +---------------------------------------------------------------------+
The two chemists were employed in petitioner's plant where their duties were to check the various grades and qualities of petitioner's pack of fruit products and to prepare samples to be distributed for the purposes of securing additional customers. Traveling expenses were incurred by these chemists in attending processing schools where annual refresher courses were given. These courses acquainted the chemists with newer developments in the processing industry. C. a. Rodegerdts was regularly employed by the petitioner as an executive assistant to its president. His primary duties consisted of contact work with respect to financing petitioner's business and conferring with Federal officials with respect to petitioner's compliance with the Federal Pure Food & Drug Act. His traveling expenses were incurred while performing such duties. The other expenses set out in the preceding paragraph were incurred by the petitioner with respect to work performed by its chemists in inspecting the quality of petitioner's fruit products and preparing samples for distribution. The total of all these expenses in the amount of $8,655.17 were ordinary and necessary expenses of petitioner's business.
In determining deficiencies for the years 1940 to 1944, inclusive, the respondent made the following adjustments contested by petitioner: (1) he reduced the gross income for the years 1939, 1940, and 1941, respectively; (2) he transferred the expenses of brokerage fees and the estimated freight and cost of preparing the goods in question for shipment which were claimed as deductions by the petitioner for the years 1939, 1940, and 1941, respectively, to the years 1940, 1941, and 1942, respectively, on the basis that such brokerage fees were paid, and the goods labeled, cased and shipped out, in these latter years (3) he transferred the expense of casing the goods sold to the United States Government from the year in which claimed as a deduction (1944) to the year in which such casing took place (1945); and (4) in computing the amount of the 1943 net operating loss deduction carried back from the year 1945, he disallowed the deduction for certain expenses totaling $9,402.75 on the basis that these expenses represented capital expenditures. Of this amount petitioner contests the disallowance of the 1945 expenses set out above in the amount of $8,655.17.
OPINION.
HILL, Judge:
The first issue concerns the question whether petitioner erroneously reported accrued income from sales of certain unshipped and unpaid for goods in the taxable years in which it billed its buyers for such goods. Petitioner contends that, in accordance with its agreements with its buyers, sales took place and title to the goods which the buyers had not ordered out by the agreed billing dates passed to these buyers when the petitioner billed them for the goods. In the alternative, the petitioner contends that regardless of the passage of title its method of accruing the sales price for the goods on its returns for the years in which it billed its customers clearly reflected its income and must be recognized for tax purposes. It is respondent's position that petitioner's right to accrue such income depends on the question of when the goods were sold with title passing and that title to the goods in question did not pass until the goods were shipped out and paid for in the taxable years following the years in which the goods were billed.
With respect to the method of reporting income, section 41 of the Internal Revenue Code provides as follows:
SEC. 41. GENERAL RULE.
The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer's annual accounting period is other than a fiscal year as defined in section 48 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year.
It appears from the evidence that petitioner's method of computing accrued income from the sales was in accordance with the method of accounting it regularly employed in keeping its books. Accordingly, the question for determination is whether the method employed by the petitioner clearly reflected its income. (Section 41, supra.)
As the facts indicate, we are dealing with a manufacturer of canned goods whose principal source of income is derived from the sales of its goods. We are particularly concerned with the question as to the periods in which income from the sale of certain of these goods should fall. On the respective dates on which the petitioner claims to have realized income from such sales, no part of the purchase price had been received. The goods were not ready for delivery, being uncased and unlabeled. Petitioner remained liable to ship them out. Furthermore, although it has not been definitely established, a substantial quantity of the goods was probably under pledge as security for loans when they were billed. Under such circumstances we are convinced that it is incumbent upon the petitioner to prove that the particular goods in question were sold and title passed to its buyers on the billing dates if it is to sustain its position that the method of accruing the income from these sales clearly reflected its income. Accordingly, we reject petitioner's alternative contention.
The question as to when title passed is also pertinent with respect to what goods should have been included in petitioner's closing inventories for the taxable years in question, in accordance with the provisions of section 22(c) of the Code and the applicable Regulations thereunder.
SEC. 22. GROSS INCOME.(c) INVENTORIES.— 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.Regulations 111:Sec. 29.22(c)-1. NEED OF INVENTORIES.— In order to reflect the net income correctly, inventories at the beginning and end of each taxable year are necessary in every case in which the production, purchase, or same of merchandise is an income-producing factor. The inventory should include all finished or partly finished goods and, in the case of raw materials and supplies, only those which have been acquired for sale or which will physically become a part of merchandise intended for sale, in which class fall containers, such as kegs, bottles, and cases, whether returnable or not, if title thereto will pass to the purchaser of the product to be sold therein. Merchandise should be included in the inventory only if title thereto is vested in the taxpayer. Accordingly, the seller should include in his inventory goods under contract for sale but not yet segregated and applied to the contract and goods out upon consignment, but should exclude from inventory goods sold (including containers), title to which has passed to the purchaser. A purchaser should include in inventory merchandise purchased (including containers), title to which has passed to him, although such merchandise is in transit or for other reasons has not been passed to him, although such merchandise is in transit or for other reasons has not been reduced to physical possession, but should not include goods ordered for future delivery, transfer of title to which has not yet been effected.
Since the contracts in question were entered into and performed in the State of California, the law of that state is applicable to the question of passage of title.
The Pacific Coast F.O.B. Canned Foods Contract, introduced in evidence, was employed by the petitioner in contracting for all of the sales of the goods in question. It contained on its face terms of purchase and sale; however, we can not conclude from the use of such terms that a present sale was intended. Parties frequently intend a contract to sell even though they employ the present tense of the verbs sell, purchase, buy, and the like. Their intent must be gathered from the contract as a whole.
The contracts entered into before the canning season could not have been present sales since the goods subject to such contracts were not then in existence.
Woodbine v. Van Horn, 29 Cal.2d 95, 173 P.2d 17; MacRae v. Heath, 60 Cal.App. 64, 212 P. 228; Walti v. Gaba, 160 Cal. 324, 116 P. 963.
Nor does the petitioner contend that any of these or any of the contracts entered into after the canning season were present sales. In fact it is petitioner's position that title passed at a date subsequent to those on which the contracts were entered into. Furthermore, from a consideration of the contract as a whole, we believe the parties intended to enter into a contract for the sale of goods in the future, and we so hold.
Section 1725(3) of the Civil Code of California:Sec. 1725. Existing and future goods. * * *(3) Where the parties purport to effect a present sale of future goods, the agreement operates as a contract to sell the goods and as soon as the seller acquires the goods the property therein shall pass to the buyer without further act if the parties so intend unless the agreement otherwise provides.See also: Schiffman v. Richfield Oil Co., 8 Cal.2d 211, 64 P.2d 1081.
We are not concerned with the question as to the passage of title in the goods delivered in due course prior to the billing dates (December 31 of each year). With respect to the goods which the buyers had not ordered delivered by December 31 of each year, the contract contains no specific provision relative to the passage of title. It does set out the procedure to be followed with respect to such goods. In accordance with the language of the contract if the seller elected to withhold shipment at the buyer's request then the goods (fruit products in this case) unshipped were to be billed to the buyer on December 31 with the seller was to draw a draft for the purchase price and procure a warehouse receipt covering the goods to accompany the invoice. These documents were then to be forwarded to the buyer who was to pay the draft within ten days and obtain his warehouse receipt. The seller was to insure the goods for the buyer's account and the buyer was to reimburse the seller at a fixed rate per month for the cost of insurance and storage. The seller was to ship the goods to the buyer when requested.
It appears that the issuance of the warehouse receipt to the buyer and the payment of the purchase price in accordance with the terms of the written contract protected the rights of both seller and buyer. However, the language of the contract is not conclusive as to the exact time title passed, and this issue is complicated by the fact that petitioner in its usual practice of dealing with its customers admittedly did not follow the written provisions of the contract.
In many instances the petitioner merely sent its buyers an invoice. We know that some of the goods so invoiced were not paid for until delivered but there is no other evidence as to when the rest of the goods billed on open account were paid for. In some instances the petitioner drew drafts to accompany the invoices but it never provided its buyers with warehouse receipts unless so requested. The evidence fails to indicate what quantities of the goods billed out in the years in question were covered by warehouse receipts.
Petitioner contends, however, that despite the terminology of the contract its methods of billing customers were in accordance with established trade practices of the California canning industry with respect to goods being sold under the Pacific Coast F.O.B. contract. Petitioner further alleges that it contracted in accordance with such trade practices and that accordingly they must be recognized as part of its agreements with its buyers. Petitioner's evidence establishes believe that the same should be given effect as being part of its contracts with its buyers.
The effect of this departure from the strict terms of the written contract forces us to look beyond the writing to determine the question of passage of title to the unshipped goods.
Petitioner argues that it was the general understanding of the canning industry as a whole that title to such unshipped goods passed to buyers on the billing dates, regardless of the fact that the goods were not labeled, cased, nor in any way segregated or identified as being subject to the contract of any one buyer rather than another, and regardless of the fact that a substantial portion of the goods may have been under pledge to banks as security for loans made to the canners. The evidence introduced by the petitioner appears to establish the fact that the California canners interpreted the sales agreement as modified by usage to pass title to the buyers on the billing dates. It is to be noted, however, that such an interpretation of the agreement would apparently work to the disadvantage of buyers by giving them less than they would have been entitled to under the written terms. Petitioner's evidence has failed to establish as a fact that buyers placed the same interpretation on their agreements with respect to the passage of title as did the canners. In any event, we believe the title did not pass on the respective billing dates because the goods subject to each of the buyers' contracts were not yet ascertained, a basic prerequisite for the passage of title.
See: Williston, Contracts, Secs. 648, 652, with respect to collateral agreements added to written contracts by usage.
Section 1737 of the Civil Code of California:Sec. 1737. No property passes until goods are ascertained. Where there is a contract to sell unascertained goods no property in the goods is transferred to the buyer unless and until the goods are ascertained, but property in an undivided share of ascertained goods may be transferred as provided in section 1726.
Petitioner seeks to apply the fungible goods doctrine, however, and argues that there were in existence sufficient fruit products of the varieties, grades, and sizes of cans to meet all contract requirements, that these goods were fungible and that the buyers on the billing dates took title to a specific or ascertained mass of canned goods as tenants in common of the entire mass.
It is interesting to note that if this doctrine were to apply there would not be one mass to which title would pass but rather there would be as many specific masses as there were different canned fruit products and different grades, sizes, and varieties thereof. But even recognizing the fungible nature of the canned goods within such narrow confines, it is essential in any application of the fungible goods doctrine that the parties should have intended to pass title in a share of an undivided mass of goods. The problem in this respect is set out in Vold on Sales at page 188:
Section 1726 of the Civil Code of California:Sec. 1726. Undivided shares. (1) There may be a contract to sell or a sale of an undivided share of goods. If the parties intend to effect a present sale, the buyer, by force of the agreement, becomes an owner in common with the owner or owners of the remaining shares.(2) (Fungible goods.) In the case of fungible goods, there may be a sale of an undivided share of a specific mass, though the seller purports to sell and the buyer to buy a definite number, weight or measure of the goods in the mass, and though the number, weight or measure of the goods in the mass is undetermined. By such a sale the buyer becomes owner in common of such a share of the mass as the number, weight or measure bought bears to the number, weight or measure of the mass. If the mass contains less than the number, weight or measure bought, the buyer becomes the owner of the whole mass and the seller is bound to make good the deficiency from similar goods unless a contrary intent appears.
The most difficult problem to solve in applying the law of fungible goods is the question of fact whether the parties in the case in hand intended their bargain to be for an undivided joint interest in the mass. It may often happen that, though the seller has a mass of goods on hand either strictly fungible or readily susceptible by agreement of being treated by the parties as fungible, yet the actual agreement the parties make does not or may not contemplate the passing of the property in an unseparated joint interest in this mass. Thus, where the bargain is merely to sell an agreed amount of goods of a certain kind and quality, the ordinary case of a contract to sell unspecified goods, no property in any joint interest vests in the buyer even though the seller has on hand the requisite stock of goods from which to perform his contract. The buyer in such cases has not agreed to become the owner of a joint interest with the seller in any specific mass of goods, and the seller has not agreed to transfer any particular goods. The contract therefor clearly remains executory until certain specific goods are appropriated to the contract.
The petitioner's evidence is insufficient to prove the necessary intent in this respect. We hold that title to the unshipped and unpaid for goods did not pass to petitioner's buyers in the years claimed. Accordingly, we hold that petitioner's method of accruing income from such sales did not clearly reflect its income, and we uphold the respondent's reallocation of such income among the years in question.
The second issue concerns the petitioner's right to take as deductions, in the taxable years in which unshipped goods were billed to buyers, the accrued expenses of brokerage fees incurred in connection with the sales of these goods. Petitioner introduced evidence with respect to the customary practice of the members of the California canning industry in accruing the expenses of such fees on their books as of the dates the unshipped goods were billed. Petitioner failed to introduce in evidence its agreements with its brokers and accordingly we do not know whether the parties contracted in accordance with any such trade practice put in evidence by the petitioner. It may well be that petitioner's liability for the brokerage fees did not become fixed until it received payment of the purchase price for the goods sold. Because of failure of proof in this respect, we hold that petitioner has not shown that the respondent erred in denying the deductions for such expenses when claimed and in allowing them for later years when the goods were paid for.
The third issue concerns petitioner's right for the purposes of income tax deductions to accrue, in the year in which it undertook the contractual liability to ship certain goods, estimates of various expenses with respect to the shipment of these goods in later taxable periods. This issue involves accrual of shipping expenses in the years 1939, 1940, and 1941 with respect to the unshipped goods billed to buyers on December 31, 1939, 1940, and 1941, respectively, and also the accrual of similar expenses in 1944 with respect to goods sold to the United States Government in 1944 but not delivered until 1945. The expenses involved are certain costs for labeling, packing, and freight.
Petitioner argues that its liability to perform the services was fixed in each of the years in which it contracted for the sale of the goods and that the expenses incurred in the performance of the services accrued on the respective billing dates. The general rule is well established that the expenses are deductible in the period in which the fact of the liability therefor becomes fixed and certain. Dixie Pine Products Co. v. Commissioner, 320 U.S. 516; Security Flour Mills v. Commissioner, 321 U.S. 281; United States v. Anderson, 269 U.S. 422.
The evidence presented indicates that all of the goods in question were labeled, cased, and prepared for shipment in a taxable period subsequent to the taxable years in which the petitioner undertook the liability to do so. Likewise, the movement of the goods for which freight expenses were incurred took place in subsequent taxable years. It was not until these events occurred that the fact of the petitioner's liability for the expenses therefor became fixed and certain. Spencer, White & Prentis, Inc. v. Commissioner, 144 F.2d 45. Accordingly, we hold that the petitioner was not entitled to accrue these expenses in the years in which it undertook the duty to perform the related services and billed buyers for unshipped goods.
The fourth issue concerns the deductibility of certain expenses in the amount of $8,655.17 incurred by the petitioner in the year 1945. Although the petitioner's tax liability for the year 1945 is not before us, nevertheless, the issue with respect to the 1945 business deductions is properly raised with respect to the petitioner's right to a net operating loss carry-back to the year 1943. Since we have found that these expenses were ordinary and necessary business expenses for the year 1945, they are deductible in accordance with the provisions of section 23(a) of the Code and are to be included in the computation of the net operating loss deduction, and we so hold.
Reviewed by the Court.
Decision will be entered under Rule 50. OPPER, J., dissenting: The practice of disapproving consistent accounting systems of long standing seems to me to be exceeding all reasonable bounds. See Heer-Andres Investment Co., 17 T.C. 786. Methods of keeping records do not spring in glittering perfection from some unchangeable natural law but are devised to aid business men in maintaining sometimes intricate accounts. If reasonably adapted to that use they should not be condemned for some abstruce legal reason, but only when they fail to reflect income. There is no persuasive indication that such a condition exists here. On the contrary, a whole industry apparently has adopted the method used by petitioner.
It will not do to say that respondent should not have disturbed petitioner's accounting method, but that since he has done so, we are powerless to do otherwise. As long as we continue to approve the imposition of theoretical criteria in so purely practical a field, respondent will go on attempting to seize on such recurring fortuitous occasions to increase the revenue, even though he may actually accomplish the opposite. Cf. Heer-Andres Investment Co., supra; Robert G. Frame, 16 T.C. 600. I think it evident that petitioner's generally recognized accounting system did not distort its income and that it should be permitted to continue to use it. Cf. Atlantic Coast Line R.R. Co., 4 T.C. 140.
VAN FOSSAN, MURDOCK, LEECH, JOHNSON, and TIETJENS, JJ., agree with this dissent.