1946 U.S. Tax Ct. LEXIS 36">*36
1. Excess Profits -- Base Period -- Abnormal Deductions in Base Period -- Consequence of an Increase in Gross Income --
2. Deduction -- Capital Expenditure or Expense. -- An amount paid by the petitioner pursuant to a court decree against a subsidiary was a capital expenditure by the petitioner in the acquisition of the assets of the dissolved subsidiary rather than a deductible expense of the operation of the business of the petitioner.
3. Excess Profits -- Base Period -- Abnormal Deductions in Base Period -- Consequence of a Change in Manner of Operation -- 711 (b) (1) (
4. Excess Profits -- Base Period -- Abnormal Deductions in Base Period -- Consequence of an Increase in Gross Income -- 711 (b) (
7 T.C. 1142">*1143 The Commissioner determined deficiencies of $ 1,619,074.50 and $ 2,114,622.331946 U.S. Tax Ct. LEXIS 36">*38 in the petitioner's excess profits tax for 1941 and 1942. The petitioner assigns as error the failure of the Commissioner to disallow the following abnormal deductions for 1939 in computing the petitioner's excess profits credit based upon income under
(a) $ 668,067.70 representing the portion of refunds made in 1939 on excessive gas rates collected in 1936.
(b) $ 206,616 paid by the petitioner in 1939 pursuant to an award of the Federal Power Commission made in that year against San Joaquin Light & Power Corporation, a former subsidiary of the petitioner, the assets and liabilities of which had been taken over by the petitioner in 1938.
(c) $ 77,572.30 representing San Joaquin Light & Power Corporation accounts acquired by the petitioner in the manner just mentioned, which became worthless in 1939 and were deducted in that year as bad debts.
(d) $ 794,678.51 representing loans to the San Francisco Bay Exposition, which became worthless in 1939.
The petitioner also contends in the alternative that the $ 206,616 involved in (b), represented a part of the cost to the petitioner of the assets of San Joaquin Light & Power Corporation which should have been capitalized 1946 U.S. Tax Ct. LEXIS 36">*39 and for which the petitioner was not entitled to any deduction in 1939. It also contends in the alternative that, if the deductions referred to in (b) and (c) are not to be disallowed because of the provisions of
FINDINGS OF FACT.
The parties have filed a stipulation of facts, which is incorporated in its entirety in these findings of fact by this reference.
The petitioner filed its excess profits tax returns for the calendar years 1941 and 1942 with the collector of internal revenue for the first district of California.
7 T.C. 1142">*1144 The loans which the petitioner made to the San Francisco Bay Exposition were made with the expectation that they would be repaid. The petitioner made the loans because it believed that the exposition would be of extreme benefit to the community served by the petitioner, and those benefits would in turn benefit the petitioner.
The petitioner realized very little, if any, profit from the1946 U.S. Tax Ct. LEXIS 36">*40 electric and gas service furnished to the exposition. The exposition was not a desirable outlet for electricity and gas furnished by the petitioner because of the temporary character of the exposition.
The petitioner was the only public utility which could have supplied the needs of the exposition for electricity and gas.
OPINION.
The facts essential to an understanding of the first issue may be stated briefly. The California Railroad Commission ordered the petitioner to reduce its rates for natural gas in July 1933. The petitioner made no change in its rates until May 1, 1936, when it reduced them to the level prescribed in the order. Meanwhile, it collected and reported as income the full amounts due under the old rates. It contested the order of the Commission in the Federal courts continuously until a final unfavorable decision was rendered in 1939. The petitioner then had to refund the excessive amounts collected from July 1933 to May 1, 1936. Those refunds were made in 1939 for which year a deduction was claimed and allowed representing the full amount of the refunds. The petitioner now contends that the entire deduction allowed for 1939 tax purposes should be disallowed, 1946 U.S. Tax Ct. LEXIS 36">*41 as abnormal under
The respondent makes only one contention in support of his determination on this item and tacitly agrees that otherwise the entire abnormal deduction should be disallowed. His argument is based upon the fact that the petitioner included in its income for 1936 the full amount of the excessive rates which it collected for the period January 1 to May 1, 1936. He reasons that the excessive collections for those four months of 1936 represented an increase in gross income of the base period over what the gross income of the base period would have been if the excess rates1946 U.S. Tax Ct. LEXIS 36">*42 for that short period had not been collected, 7 T.C. 1142">*1145 and since the refund in 1939 of that excess was a consequence of the collection of the excess in 1936,
Heretofore, the gross income of one of the four years making up the base period has been compared with the gross income1946 U.S. Tax Ct. LEXIS 36">*43 of the other years, or the gross income of a portion of the base period has been compared with the gross income of some other period or periods, to determine whether there has been an increase in gross income during the base period or during some portion of it.
We conclude that the construction placed upon 711 (b) (1) (
The petitioner's second contention is that a deduction of $ 206,616 which it claimed and was allowed in 1939 should be disallowed in computing its income credit under
The award, made in 1939 covered liability for usage charges for years from 1923 to 1938 inclusive. Since payment by you in 1939 of this liability incurred by San Joaquin Light and Power Co. resulted from the liquidation transfer of assets at December 31, 1938, as previously set forth herein, the deduction was the consequence of a change in size, condition, and manner of operation of your business. Elimination of the deduction as abnormal is therefore denied under
One of the contentions made by the petitioner is that this item was not a proper deduction from income for 1939. No consideration need be given to
The above is in accordance with the holding of the court in
The claims did not arise out of the operation of the business of petitioner. The expense of settling them was not an operating expense or operating loss of that business, but a part of the cost of acquisition of the property of the partnership; * * *
* * * While the assets of the 1946 U.S. Tax Ct. LEXIS 36">*49 partnership transferred to the petitioner took the same cost basis in its hands as they had in the hands of its transferor, there is no justification for a ruling that petitioner could deduct from the gross income of its business, expenses or losses attributable to the operation of the business by its predecessor.
The present case is not distinguishable from the
The petitioner acquired accounts receivable of San Joaquin in the liquidation already described. More than $ 82,000 of those accounts were ascertained to be worthless during 1939 and were charged off. A deduction was claimed and allowed on the return1946 U.S. Tax Ct. LEXIS 36">*50 for that year. The parties are agreed that this deduction was abnormal under
The petitioner, prior to 1939, had furnished various services as a public utility in a large area surrounding San Francisco Bay. Its subsidiary, San Joaquin, had furnished similar services in the San Joaquin Valley. The petitioner, in other words, carried on business as a public utility directly, and it also carried on some business indirectly through its large subsidiary, from which it received substantial dividends. It dissolved the subsidiary at the end of 1938 and thereafter operated both branches of the 1946 U.S. Tax Ct. LEXIS 36">*51 business directly. That was a distinct change in the manner of operation of the business engaged in by the petitioner. The change led directly to the abnormality. The bad debt deductions which gave rise to the abnormality might have been taken by San Joaquin, but not by the petitioner, if the change just mentioned had not been made. It is not contended that there would have been any abnormality if these deductions had not been taken by the petitioner. Not only has the petitioner failed to show that the abnormality was not a consequence of a change in the manner of operation of its business, as required by
The last issue for decision relates to the disallowance of an abnormality resulting from bad debt deductions for 1939 based upon loans to the San 1946 U.S. Tax Ct. LEXIS 36">*52 Francisco Bay Corporation. The petitioner, along with others, loaned large sums of money in the early part of 1939 and in 7 T.C. 1142">*1149 prior years to the San Francisco Bay Corporation, a California nonprofit corporation, for the purpose of financing the exposition held on Treasure Island in San Francisco Bay in 1939. The petitioner advanced $ 250,000 prior to 1939 to the debtor pursuant to a general subscription agreement, and it loaned an additional amount of $ 825,000 in the latter part of 1938 and up to May 3, 1939, pursuant to another agreement. A number of others were parties to both agreements. These loans were secured by a pledge of revenues of the exposition and were covered by interest-bearing notes. These were all loans, not contributions. Partial payments were made on the indebtedness, but the exposition did not have the expected financial success and the petitioner determined in 1939 that the debts were worthless to the extent of $ 794,678.51. That amount was charged off its books and allowed as deductions on its return for 1939. The Commissioner, in determining the deficiencies for 1941 and 1942, refused to disallow this deduction on the ground that the petitioner1946 U.S. Tax Ct. LEXIS 36">*53 had not established that the abnormality was not a consequence of an increase in the gross income of the taxpayer in its base period and was not a consequence of a change at any time in the type, manner of operation, size or condition of the business engaged in. He said that information on hand indicated that the petitioner's gross income was materially increased during the progress of the exposition in 1939 and in previous years in the base period.
The petitioner was the only public utility in the San Francisco Bay area which could have supplied the needs of the exposition for electric and gas service. It derived some business directly from the exposition. Total billings to the exposition for the period 1937 to 1940 amounted to $ 603,160.09. This represented only a small part of the petitioner's gross revenues during that period. The exposition business brought little profit to the petitioner and was not a desirable type of business because of its temporary character. The petitioner made the loans along with others because it believed that the exposition would benefit the area served by the petitioner and those benefits would, in turn, indirectly benefit it, and it made the1946 U.S. Tax Ct. LEXIS 36">*54 loans with the expectation that they would be repaid in full.
The only question presented for decision on this issue is whether the disallowance of the deduction is precluded by any of the provisions of
The respondent suggests in his brief that the $ 285,000 item was a contribution rather than a loan. The evidence shows, however, that it was a loan and not a contribution. Furthermore, if it were a contribution, the petitioner would not have been entitled to any deduction in 1939 and he would win as to a part without consideration of
7 T.C. 1142">*1150 The respondent's main argument is that the abnormality in the bad debt deductions was a consequence of the increase in gross income produced by the exposition and was a consequence of a change in the type, manner of operation, size, or condition of the business, since the loans were made for the purpose of increasing the business and accomplished that result. That kind of an argument is fallacious, as we have heretofore pointed out.
The gross income of the petitioner increased during 1939, but the evidence shows that the abnormality in the bad debt deductions based upon loans to the exposition was not a consequence of the increase in gross income. An abnormality in bad debt deductions based upon accounts receivable due from customers for services rendered might be a consequence of an increase in gross income and the corresponding increase in accounts receivable of that type. But the abnormality here in question did not result from increased accounts receivable due from customers for services rendered. Neither the loans nor the resulting bad debts were caused by, or were a consequence of, any increase in gross income. The occurrence of an increase in gross income1946 U.S. Tax Ct. LEXIS 36">*56 did not lead in any way to the lending of the money, and, once the loans were made, their repayment depended upon factors other than the amount of the gross income of the petitioner. The abnormalities would have occurred regardless of whether or not there was any change in the gross income of the petitioner. There was no change in the type, manner of operation, or condition of the San Francisco Bay area business of the petitioner during the period of these loans and, consequently, the abnormality could not have been a consequence of any changes of that kind. The petitioner's business in that area grew, but, as we have heretofore stated, the growth did not cause or contribute to the loss on the bad debts and the loss was not a consequence of the change in the size of the business. We find no merit in the respondent's argument based on