Opinion
Docket Nos. 107205-107208.
Promulgated June 9, 1943.
Petitioners' transferor, a Kansas corporation, was engaged in the business of furnishing engineering services for the construction of petroleum processing plants. It kept its books of account and made its income tax returns on the accrual basis, using the completed and accepted contract basis for long term contracts. At a special meeting of the stockholders on August 9, 1938, a resolution of dissolution was adopted. This was just a few days before the completion of an oil refinery in Roumania, upon the acceptance of which the transferor was entitled to receive a large remuneration. Such payment was received shortly thereafter by trustees for the stockholders and distributed to them. Held, that the income received under the contract was income to the transferor in 1938.
Harry V. Gott, Esq., and Elmer E. Fox, C. P. A., for the petitioners.
John E. Marshall, Esq., for the respondent.
These proceedings, consolidated for hearing, involve transferee liability of petitioners for deficiencies of $13,649.53 in income tax and $1,881.67 in excess profits tax of the Pershell Engineering Co. for 1938. On August 9, 1938, the stockholders of the corporation passed a resolution of dissolution which was filed in the office of the Secretary of State of Kansas on August 11, 1938. The question in issue is whether the transferor has a liability for income tax and excess profits tax for 1938 upon the profits of a long term contract which was completed in 1938 and payment therefore made shortly after the filing in the office of the Secretary of State of Kansas of the resolution of dissolution.
FINDINGS OF FACT.
The petitioners, residents of Wichita, Kansas, are former stockholders of the Pershell Engineering Co. (hereinafter sometimes referred to as Pershell) with its principal office at Wichita, which filed its income and excess profits tax return for 1938 with the collector at Wichita.
At all times material hereto, the Winkler-Koch Engineering Co., a Kansas corporation (hereinafter referred to as W-K), was engaged in the business of designing distillation, fractionation, cracking, and other equipment for petroleum oils, and in selling engineering services in connection with such equipment; and it had developed special processes and equipment.
At all times material hereto, A. F. Craig Co., Ltd., a Scottish corporation (hereinafter referred to as Craig), was a fabricator and erector of such equipment. Craig was desirous of increasing its business in petroleum refinery work and of selling refinery equipment designed by W-K.
On September 4, 1929, W-K and Craig entered into a written contract (called the master contract), the object of which was to better promote their respective businesses. Thereafter, Craig, pursuant to and under the terms of the master contract, proposed in writing to design, engineer, and construct a cracking and coking unit or plant at Ploesti, Roumania, for a concern of Bucharest, Roumania (hereinafter called Colombia). On or about April 21, 1937, this proposal, as revised, was accepted in writing by Colombia; and pursuant thereto, Craig and W-K commenced to design and engineer and later to construct such cracking and coking unit or plant at Ploesti, Roumania, in accordance with the terms and provisions of the master contract. The proposal, as revised and accepted by Colombia, provided for the equipment to be designed by W-K, which, through Craig, would be liable for the accuracy of the drawings and specifications and for the performance of the equipment in accordance with the guarantees; and, further:
Clause 4. Demonstration of the Unit:
Demonstration of the Unit would be by means of a "test run" under the direction of our operators. The conditions of the "test run" would be fair to both parties. The test run to be of 15 days continuous operation providing there is no failure in services. Purchasers would provide all oil, steam, water, air, fuel, chemicals and electricity in sufficient quantity and pressure (without fluctuation) for the continuous satisfactory operation of the unit during this "test run." The "test run" would be started within 30 days after the installation is completed. Our operators would put the equipment in operation and instruct purchaser's operators. Our operators would remain until the test run is satisfactorily completed and for a period not exceeding one month thereafter in order to give additional training to your operators. In case failure of tankage, oils or services render it impossible to make "test run" within Six weeks after completion of erection, A. F. Craig Co. Ltd. are not under obligation to keep an operator on the job longer than that period.
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Clause 8. Guarantees:
We guarantee that the unit when constructed and erected according to our drawings and properly operated will
(1) Be capable of handling 750 metric tons or 5260 barrels per day of residual charge as described in Clause 1.
(2) Be capable of producing a total finished stabized gasoline, except for sweetening, having and being:
25 colour or better None corrosive (ASTM copper strip at 50° C)
End point controllable between 180° C and 210° C
Octane number (Ethyl series 30 engines at 105° C jacket water and 600 r. p. m. or equivalent) of 70
Gum content not above 30 mg. (copper dish Federal Specifications Board Method 530.1)
(3) In the event of the plant failing to completely fulfil all the guarantees, we shall be allowed a reasonable period, not exceeding 3 months, in which to make alterations to enable these guarantees to be fulfilled.
(4) In the event of the plant finally failing to fulfil completely all guarantees, we shall be paid in proportion to the amount by which the guarantees are met.
Prior to the foregoing, and on or about April 1, 1936, W-K, desiring to withdraw from the engineering business, had entered into a contract in writing (called the April 1, 1936, contract) with W. E. Perdew and G. M. Shelley of Wichita, Kansas, whereby and under the terms of which, Perdew and Shelley took over the business of designing, engineering, and supervising the construction of oil refinery plants and equipment from W-K and assumed certain duties and obligations of W-K in that regard, and particularly the duties and obligations of W-K under the master contract; and it thereupon became the duty of said Perdew and Shelley thereunder to design, engineer, and supervise the installation of the Ploesti plant. Under this contract, in consideration of the promises and agreements of Perdew and Shelley and the full and complete performance thereof, W-K agreed, among other things:
5. To continue to hold and operate under contracts and agreement with A. F. Craig Company and to pay to the parties of the second part eighty-two and one-half per cent (82 1/2%) of all money if, when and as actually received thereunder, or in connection therewith.
The contract also provides:
It is further agreed by and between the parties hereto that the parties of the first part shall have the right at any time within three years from this date and after six months from this date to terminate this contract to the extent herein set forth, provided that written notice of such termination shall be served upon parties of the second part, or their successor, by parties of the first part, not less than 60 days prior to the date upon which parties of the first part desire such termination to become effective.
Upon cancellation or termination of this contract all work in progress including all signed contracts shall be carried to completion under the terms of this agreement.
On or about July 23, 1936, Perdew and Shelley caused to be organized, under and pursuant to the laws of the State of Kansas, a corporation to take over and assume their duties and obligations under the April 1, 1936, contract, to be known as the Pershell Engineering Co., which corporation was authorized to carry on the same type of business as W-K was authorized to carry on.
Also, on or about July 23, 1936, Perdew and Shelley, for valuable consideration, assigned in writing the April 1, 1936, contract to Pershell, which company thereby assumed and undertook the duties and obligations of Perdew and Shelley with respect to the April 1, 1936, contract. One sentence of the assignment reads in part as follows: Pershell "also hereby assumes and agrees to promptly and faithfully discharge each, every and all of the obligations which the Parties of the First Part undertook and assumed under and by virtue of the said [April 1, 1936] contract."
On or about December 1, 1936, pursuant to the provisions of the April 1, 1936, contract, W-K served notice in writing upon Perdew and Shelley that the April 1, 1936, contract would terminate on February 1, 1937.
The Ploesti plant was a special plant designed to meet Roumanian requirements. It was experimental; no other engineering or refining company in the world had ever tried to construct just that sort of unit.
Pershell carried on the actual engineering and designing work. In the latter part of 1937 or early part of 1938, Pershell furnished Craig with two operators, who were sent to Roumania to see that everything was in proper shape and everything in position before the test run was started, to help test out and start the plant, to help put it into operation, and to help it meet its guarantee run. These operators were paid by Pershell, and Craig reimbursed W-K, which reimbursed Pershell, for their salaries and traveling expenses.
The first attempt to make a test run of the Polesti plant was at some time in April or May 1938. A number of attempted test runs were made. These test runs would get started and the vapor separator would coke up, or something would happen, "and they would have to be shut down." On August 15, 1938, W-K received a cable from Craig which read:
HAVE RECEIVED FOLLOWING WIRE FROM PLOESTI COMPLETED TEST RUN MADE GUARANTEES SHUTTING DOWN CLEARING STOP REMOVING VAPOUR SEPARATOR DECKS DIFFERENTIAL PRESSURE EXCESSIVE DUE TAR ENTRAINMENT LOWERING INLET HIGH BOTTOM SEDIMENT.
Prior to the receipt of the foregoing cable, and on August 9, 1938, the stockholders of Pershell were notified that a special meeting of the stockholders would be held on that day for the purpose of considering and acting upon a resolution distributing the assets of the company to the stockholders, and for the purpose of considering and acting upon the following resolution:
WHEREAS, The Pershell Engineering Company, a Kansas corporation, has liquidated all and entire its obligations and has no outstanding indebtedness of any kind or character;
THEREFORE, BE IT RESOLVED that the said corporation be and it is hereby dissolved and shall, upon the filing of a copy of this resolution properly adopted and certified by the President and Secretary of said corporation in accordance with the laws of the state of Kansas, cease to exist;
RESOLVED FURTHER that the President and Secretary of this corporation be and they hereby are ordered and directed to file a copy of this resolution certified by them in the office of the Secretary of State of the State of Kansas.
The stockholders promptly signed a waiver of notice and consented to the holding of the special meeting on August 9, 1938, at which a resolution was adopted to dissolve the company, but the minutes are silent about distributing the assets of the company to the stockholders.
On August 11, 1938, the Secretary of State for the State of Kansas advised that the resolution of dissolution had been received and filed as of that date.
On August 11, 1938, Pershell had not received any report that the test run was proving successful. If it had not been successful Pershell had the Ploesti plant "to complete if alterations and what-not might have been necessary to meet its guarantees. That job was not wound up. The books were not closed." On such date (August 11, 1938) "Nothing remained but to complete that job and distribute the assets, if any."
Pursuant to the terms of the master contract and of the April 1, 1936, contract, W-K drew three checks as follows:
Check No. 1751, dated October 31, 1938, payable to Perdew-Shelley, et al., in the amount of $39,270, signed by The Winkler-Koch Engineering Company.
Check No. 2148, dated January 3, 1939, payable to Pershell Engineering Company, signed by The Winkler-Koch Engineering Company, in the amount of $45,905.06, and endorsed "Deposit for Perdew-Shelley, et al., by G. M. Shelley."
Check No. 2624, dated March 10, 1939, payable to Perdew, Shelley, et al., drawn and signed by The Winkler-Koch Engineering Company, in the amount of $20,356.16, endorsed "Deposit to account of Perdew-Shelley, et al."
These were the only checks received from the Ploesti, Roumania, contract and the proceeds from these three checks were distributed to the stockholders of Pershell in proportion to their stockholdings.
At all times material hereto, the stockholders of Pershell, together with the number of shares held by each, were as follows:
W. E. Perdew ............. 59 shares Harry Litwin ............. 40 shares C. C. Chapin ............. 1 share H. B. Dunn ............... 1 share G. M. Shelley ............ 29 shares Erma B. Shelley .......... 30 shares
C. C. Chapin and H. B. Dunn had no beneficial interest in the corporation, but each held one share of stock merely as qualifying stockholders and the beneficial interest in these two shares of stock belonged to Perdew and Shelley, one share each. At all times material hereto, Perdew and Shelley were president and secretary, respectively, of Pershell. At all times material hereto, the directors of Pershell were the five stockholders first above named.
Pershell maintained its books and records on the accrual basis, using the completed and accepted contract basis for computing and reporting income from long term contracts, and it filed its Federal income tax returns on that basis.
Pershell treated its part of the work in connection with the designing, engineering, and construction of the Ploesti plant as a long term contract on its books of account, and it treated on its books as a deferred cost the expenditures made by it in connection therewith.
Pershell did not report any income from its contract to design, engineer, and supervise the installation of the Ploesti plant; and upon audit of its return for 1938, respondent determined $82,791.64 as additional engineering income, with this explanation in the notice of deficiency:
This adjustment represents income derived from engineering services rendered in connection with the construction of an oil refinery in Roumania, no part of which was reported on the return. * * *
If this adjustment represents income of Pershell, petitioners admit that they are liable as transferees for the full amount of their liabilities as determined by the Commissioner.
Petitioners made returns showing liquidation gain on dissolution, which included this Roumanian contract, and they reported it as capital gain.
OPINION.
The issue presented by these proceedings is whether the Pershell Engineering Co., the petitioner's transferor, is liable for income tax in respect of the profits received in 1938 from the completion and acceptance of an oil refinery in Roumania, the design, drawings, and specifications for which were furnished by Pershell. Pershell kept its books of account and made its income tax returns upon the accrual and long term completed and accepted contract basis. The construction of the oil refinery began in 1936. It was nearing completion in the late summer of 1938. The Roumanian company for whom the refinery was being built was not liable to pay the full contract price until the refinery had been completed and operations had successfully met the prescribed conditions of a 15-day test run. This 15-day test run began late in July 1938. The 15-day period would end on August 13. Immediately prior thereto, or on August 9, the stockholders of Pershell hurriedly called a stockholders' meeting at which a resolution was passed declaring that the corporation had "liquidated all and entire its obligations and has no outstanding indebtedness of any kind or character" and further resolving that the corporation be dissolved. A copy of this resolution was forwarded to the Secretary of State of Kansas and filed in his office on August 11, 1938. The petitioners contend that such actions taken effectually dissolved the corporation under the laws of Kansas in 1938; that since the dissolution was effected prior to the completion of the Roumanian contract the remuneration which was received thereafter was not income of Pershell but was income only of the stockholders who actually received it from their trustees.
The respondent denies that Pershell had liquidated all and entire its obligations and that it had no outstanding indebtedness as of August 9, 1938, or August 11, 1938. He points out that Pershell was not entitled to receive any income whatever from the Roumanian job until after the 15-day continuous test run had shown that the plant when completed would meet the guarantees made with respect to its performance; that if it had not met those guarantees Pershell would have been indebted to Craig to the extent of double the payment due W-K from the job for the failure of the equipment or installation to meet the guarantees. It is also in evidence that Pershell's income tax return for 1938 shows that on August 9, 1938, it had the following liabilities:
Accounts payable ........................... $15,597.62 Taxes ...................................... 1,800.35 Work in progress billed .................... 19,982.34
The respondent therefore submits that Pershell was not actually dissolved on August 11, 1938, as claimed by the petitioners.
The pertinent provisions of the Kansas statutes bearing upon this point are sections 17-801, 17-808, and 17-809 of the General Statutes of Kansas, 1935, which provide as follows:
17-801. Voluntary dissolution. Any corporation that has liquidated its obligations may be dissolved by vote of the stockholders, as provided in section 17 [17-215] of this act; the resolution of dissolution shall state that the corporation has no outstanding indebtedness. Upon the filing of a copy of such resolution, certified by the president and secretary, in the office of secretary of state, the corporation shall cease to exist.
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17-808. Directors as trustees in cases of dissolution; their powers and duties. Upon the dissolution of any corporation already created by or under the laws of this state, unless a receiver is appointed by some court of competent authority, the president and directors, or managers of the affairs of the corporation, at the time of the dissolution, by whatever name they may be known in law, shall be trustees of the creditors and stockholders of such corporation, with full power to settle the affairs, collect the outstanding debts, and divide the moneys and other property among the stockholders, after paying the debts due and owing by such corporation at the time of its dissolution, as far as such money and property will enable them; and for this purpose they may maintain or defend any judicial proceeding.
17-809. Trustees responsible to creditors and stockholders. The trustees mentioned in the last section shall be severally responsible to the creditors and stockholders of such corporation, to the extent of its property and effects that shall have come into their hands.
We do not think that in the circumstances of this case it is necessary to decide whether Pershell was actually dissolved on August 11, 1938, for we are of the opinion that that corporation, keeping its books of account as it did on the accrual basis, was liable for income tax upon the amount received from the completion of the Roumanian contract.
Section 41 of the Revenue Act of 1938 provides in part:
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. * * *
Pershell is not a petitioner in these proceedings. The basis upon which the respondent held Pershell liable for an additional tax for 1938 is not before us. The respondent contends that the question presented is controlled by article 22 (a)-21 of Regulations 101 (promulgated pursuant to section 22 (a) of the Revenue Act of 1938), which reads in part as follows:
ART. 22 (a)-21. Gross income of corporation in liquidation. — When a corporation is dissolved, its affairs are usually wound up by a receiver or trustees in dissolution. The corporate existence is continued for the purpose of liquidating the assets and paying the debts, and such receiver or trustees stand in the stead of the corporation for such purposes. (See sections 274 and 298.) Any sales of property by them are to be treated as if made by the corporation for the purpose of ascertaining the gain or loss. No gain or loss is realized by a corporation from the mere distribution of its assets in kind in partial or complete liquidation, however they may have appreciated or depreciated in value since their acquisition. * * *
We do not think that this provision of the regulations is determinative of the issue presented. It has application to the case of a corporation the corporate existence of which is continued for the purpose of liquidation. But if Pershell was dissolved by the filing of the copy of the stockholders' resolution of dissolution on August 11, 1938, the Article would not be applicable.
In United States v. Anderson, 269 U.S. 422, the Court said that the accrual system was incorporated into the law:
* * * to enable taxpayers to keep their books and make their returns according to scientific accounting principles, by charging against income earned during the taxable period the expenses incurred in and properly attributable to the process of earning income during that period; * * *
In Fawcus Machine Co. v. United States, 282 U.S. 375, it was held that a corporation which kept its books of account upon the accrual basis for the year 1918 was liable for an additional tax imposed upon income for 1918 even though the act imposing the additional tax was not passed until February 1919.
In our opinion the principles applied by the Supreme Court in the above cited cases are applicable here. A corporation or other taxpayer keeping its books of account on the accrual basis, and making its returns in accordance therewith, is required to include in gross income the income which is earned during such period. No expense was paid by Pershell or by the petitioners after August 9, 1938, with reference to earning its remuneration from the Roumanian contract. In our opinion the corporation's books of account for 1938 do not correctly reflect its income. We think that the respondent had authority under section 41 of the Revenue Act of 1938 to include in the gross income the profits from the Roumanian contract.
Since the petitioners admit their liabilities for the taxes due from Pershell for 1938, provided the adjustment made by the respondent in that corporation's income tax return for 1938 is approved,
Decisions will be entered for the respondent.