* * * *

(d) On final acceptance of each vessel, payment of the balance then owing on account of such vessel shall be made to the Contractor.

The contract required petitioner to furnish all materials other than those furnished by the Government, necessary for the construction of the tugs, and all labor, including that necessary to the installation of Government furnished materials.

The contract provided that "The Contractor shall not, unless otherwise directed in writing by the Department, carry, or incur the expense1951 U.S. Tax Ct. LEXIS 309">*316 of any insurance against any form of loss of or damage to the vessels or to the materials or equipment therefor to which the Government has acquired title or which have been furnished by the Government for installation by the Contractor." The contract further provided that "Title to the Government-Furnished Material shall remain in the Government."

Under the general provisions of Contract 1847, it was provided that:

Article 3. Liens and titles. -- * * *

(c) Title to each vessel under construction shall be in the Government and title to all materials and equipment acquired for any of the vessels shall vest in the Government upon delivery thereof to the plant of the Contractor or other place of storage selected by the Contractor, whichever of said events shall first occur: Provided, that the Supervisor may by written direction require that title shall vest in the Government upon delivery of such materials and equipment 16 T.C. 118">*122 to the carrier for transportation to the plant of the Contractor or other place of storage selected by the Contractor. * * * Upon completion of each vessel, all such materials and equipment which have not been included therein and which are no longer required1951 U.S. Tax Ct. LEXIS 309">*317 therefor, except materials and equipment which were furnished by the Government, shall become the property of the Contractor.

The contract also provided that under certain specified conditions it could be suspended or terminated by the Government. It was further provided that neither the contract "nor any interest herein nor any claim arising hereunder" could be assigned by the petitioner, except that "claims for moneys due or to become due to the Contractor from the Government arising out of this contract may be assigned to any bank, trust company, or other financing institution, including any Federal agency authorized to make loans."

On or about October 2, 1944, petitioner entered into another fixed price contract, hereinafter referred to as Contract 1964, under which the petitioner contracted to construct ten 500-ton non-self-propelled steel covered cargo lighters at a price of $ 40,675 for each vessel, or a total contract price of $ 406,750. The provisions of Contract 1964 were in all material respects the same as those incorporated in Contract 1847 and which have been set out above.

At the close of its taxable year ended May 31, 1945, petitioner was engaged in the construction1951 U.S. Tax Ct. LEXIS 309">*318 but had not completed the five tugs covered by Contract 1847 and as of that date had expended in connection therewith $ 122,086.89 for materials and $ 74,800.55 for labor. Two of the tugs were completed and the contract was cancelled as to the other three during the following taxable year ended May 31, 1946.

At the close of its taxable year ended May 31, 1945, petitioner was engaged in the construction of seven of the ten lighters covered by Contract 1964, the other three lighters having been completed and delivered prior to that date. As of May 31, 1945, petitioner had expended in connection with all ten lighters $ 179,378.46 for materials and $ 158,719.16 for labor. These amounts were allocated by the petitioner between the three lighters completed prior to May 31, 1945, and the seven lighters in the process of completion as follows:

1951 U.S. Tax Ct. LEXIS 309">*319 Petitioner reported "gross sales" for the taxable year ended May 31, 1945, in the amount of $ 5,601,224.31, which sum included $ 122,025 representing the contract price of the three lighters completed and delivered during that year. Petitioner deducted as the "cost of goods sold" the sum of $ 5,075,398.37 consisting of the following items: 16 T.C. 118">*123

Included in the "materials used" and "direct labor" items set out above were the amounts of $ 59,093.54 and $ 101,615.75 allocated by petitioner to the three lighters completed and delivered in the taxable year. In determining the deficiency in excess profits tax for the taxable year ended May 31, 1945, respondent made no adjustment in respect to the receipts and expenditures reported by the petitioner on account of the three lighters completed and delivered in that year.

Of the seven lighters under construction as of May 31, 1945, five were completed during the taxable year ended May 31, 1946, during which year Contract 1964 was cancelled1951 U.S. Tax Ct. LEXIS 309">*320 as to the remaining two lighters.

Petitioner on its return for the taxable year ended May 31, 1945, reported closing inventories in the amount of $ 1,060,289.05, representing "work in progress" and consisting of the following items:

Petitioner included in the foregoing "materials" and "direct labor" the sum of $ 41,857 rather than $ 196,887.44, representing the $ 122,086.89 and $ 74,800.55 actually expended by the petitioner during the taxable year for materials and labor, respectively, in connection with Contract 1847. The sum of $ 41,857 was computed by petitioner as the "market value" of the "work in progress" on the five tugs covered by Contract 1847 as of the close of the taxable year in the following manner:

1951 U.S. Tax Ct. LEXIS 309">*321 No part of the sums of $ 120,284.92 and $ 57,103.41 expended by petitioner during the taxable year ended May 31, 1945, for materials and labor, respectively, in connection with the seven lighters covered by Contract 1964, which were uncompleted by the end of the taxable 16 T.C. 118">*124 year, was included by the petitioner in the "materials" and "direct labor" items as set out above. The petitioner's determination of a market value of zero for "work in progress" in respect to Contract 1964 resulted from the following computation:

The net effect of petitioner's valuation of its "work in progress" on Contracts 1847 and 1964 as of May 31, 1945, at a "market value" of $ 41,857 and zero, respectively, rather than at actual cost was to write off against the petitioner's income for the fiscal year ended May 31, 1945, its estimate of unrealized and anticipated losses on such contracts in the total amount1951 U.S. Tax Ct. LEXIS 309">*322 of $ 332,418.77.

Petitioner on its books charged the costs of materials and direct labor separately to each Government contract but did not maintain separate accounts of costs incurred in connection with the construction of each vessel. However, in determining its income from Government contracts, petitioner accrued on its books in the year of completion and delivery the profit or loss realized upon each vessel and computed such profit or loss on the basis of the portion of the total contract price and total contract costs allocable to each unit when completed. The costs allocated to each vessel upon completion did not include "overhead charges" which were charged to expense and deducted in the year paid or incurred.

Petitioner either received or became entitled to receive during the taxable year ended May 31, 1945, payments aggregating $ 119,619, on account of the five tugs which were under construction at the close of that taxable year, and under Contract 1964 payments aggregating $ 58,492.50 on account of the seven lighters which were under construction at the close of that taxable year. These amounts, aggregating $ 178,111.50, were credited on petitioner's books to an account1951 U.S. Tax Ct. LEXIS 309">*323 captioned "Customer Deposits" and were not included in the gross income of $ 5,601,224.31 as reported on the petitioner's return for the taxable year ended May 31, 1945, but were reported as deferred income.

Petitioner on its returns for the taxable years ended May 31, 1943, and 1944 reported as closing inventories the amounts of $ 847,229.24 and $ 813,092.16, respectively, representing "work in progress," consisting 16 T.C. 118">*125 of expenditures for materials and direct labor in connection with the construction of certain Naval vessels which had not been completed at the close of the taxable years. The amounts of $ 847,229.24 and $ 813,092.16 represented the actual cost of the materials used and the direct labor employed and none of the materials or labor represented by such expenditures could have been purchased or replaced by petitioner at the close of such taxable years for less than the actual cost.

Except as to Contracts 1847 and 1964, all the items or amounts included in petitioner's reported closing inventories figure of $ 1,060,289.05 for the taxable year ended May 31, 1945, represented the actual cost of the materials used and the direct labor employed in connection with vessels1951 U.S. Tax Ct. LEXIS 309">*324 under construction by petitioner on May 31, 1945. None of the materials or labor represented by such expenditures could have been purchased or replaced by petitioner on May 31, 1945, for less than the actual cost. The same is true as to the expenditures made by the petitioner during the taxable year for materials and direct labor on account of the five tugs and seven lighters still under construction on that date.

On petitioner's return for its first taxable year ended May 31, 1943, Question 12, "State whether the inventories at the beginning and end of the taxable year were valued at cost, or cost or market, whichever is lower" was answered: "Cost or market whichever is lower."

In his determination of the involved excess profits tax deficiency for the taxable year ended May 31, 1945, the respondent increased the net income as reported on petitioner's return for that year by the amount of $ 332,418.77, and in explanation of such adjustment the deficiency notice stated:

It has been determined that the costs of your work in progress relating to Contracts No. 1847 and No. 1964 as of May 31, 1945, were $ 196,887.44 and $ 177,388.33, respectively, that the market value of such work in1951 U.S. Tax Ct. LEXIS 309">*325 progress was not less than cost, and that your writedown of $ 155,030.44 with respect to Contract No. 1847, and complete write-off of $ 177,388.33 with respect to Contract No. 1964 should be restored to net income. Accordingly, the net income reported by you in your corporation return for the year ended May 31, 1945, has been increased in the amount of $ 332,418.77.

OPINION.

The sole issue in regard to the petitioner's tax liability for the fiscal year ended May 31, 1944, concerns the amount petitioner may properly accrue and deduct for Oregon corporation excise taxes in that year. Respondent concedes that the petitioner is entitled to deduct the sum of $ 20,965.01 which represents the tax originally reported by the petitioner in its state tax return and the amount claimed by the petitioner as a deduction in its Federal tax returns 16 T.C. 118">*126 for that year. Petitioner, on the other hand, contends that it is entitled to accrue and deduct the amount of $ 26,040.49 representing the total tax as disclosed in an amended state tax return which it filed on or about November 30, 1946.

Petitioner concedes that the additional state excise tax of $ 5,075.48 results from the elimination of 1951 U.S. Tax Ct. LEXIS 309">*326 the deduction for "Post-war Reconversion Expense" in the amount of $ 253,774.13 claimed in its Oregon corporation excise tax return as originally filed, and agrees with the respondent that the issue herein is governed by the so-called "contested tax" rule. See Dixie Pine Products Co. v. Commissioner, 320 U.S. 516">320 U.S. 516; Security Flour Mills Co. v. Commissioner, 321 U.S. 281">321 U.S. 281. The parties differ as to whether petitioner's claim of the deduction for post-war reconversion expense on its Oregon excise tax return, in the face of advice to it that this item was not properly deductible, constituted a "contest" of its liability for the additional tax which would otherwise have been due.

The right to accrue a liability for tax comes with the occurrence of all the events which fix the amount of the tax and determine the liability of the taxpayer to pay it. United States v. Anderson, 269 U.S. 422">269 U.S. 422; see G. C. M. No. 25298, 1947-2 C. B. 39. In cases involving taxpayers who contest the imposition of a tax by court action, it has been consistently held that 1951 U.S. Tax Ct. LEXIS 309">*327 the right to accrue such expense must be postponed until such time as the taxpayer's liability for the tax and the amount thereof has been finally determined. 320 U.S. 516">Dixie Pine Products Co. v. Commissioner, supra;321 U.S. 281">Security Flour Mills Co. v. Commissioner, supra.However, it is not necessary that a taxpayer institute legal proceedings in order to "contest" his liability for a tax. In Great Island Holding Corp., 5 T.C. 150, 160, we stated that:

We do not agree with petitioner's contention that the "contested tax" rule is applicable only in cases where the dispute has been carried to the courts. In our view, it is sufficient if the taxpayer does not accrue the items on its books and denies its liability therefor.

The petitioner herein did not accrue the tax in question on its books, nor can it fairly take the position that it did not deny its liability for any additional tax when it claimed the benefit of the deduction for post-war reconversion expense. The additional tax which petitioner now seeks to accrue and deduct in the fiscal year 1944 was not the result of innocent error or oversight1951 U.S. Tax Ct. LEXIS 309">*328 on the part of the petitioner but was the direct result of its deliberate and affirmative claim to a deduction in the amount of $ 253,774.13. The petitioner, with clarity and in all apparent sincerity, claimed the deduction on its state tax return, which had the practical effect of denying tax liability in any greater amount than reported. It is of no moment now to learn that petitioner's officers had been forewarned as to the unlawfulness of the deduction 16 T.C. 118">*127 or that they were unwilling to press the claim should it be disallowed, for these facts were in no manner reflected on the returns. The important considerations are that the deduction and the resulting lower tax were in fact claimed and that at no time prior to the filing of its amended return on November 30, 1946, did the petitioner in any manner recognize or concede its liability for taxes in any greater amount than originally reported and paid.

Therefore, it is our opinion that the petitioner is not entitled to accrue and deduct in computing its net taxable income for the fiscal year ended May 31, 1944, the additional tax in the amount of $ 5,075.48 which it admitted as owing for the first time on its amended return1951 U.S. Tax Ct. LEXIS 309">*329 filed in 1946.

The parties state that our decision on the first issue is determinative of the second issue relating to petitioner's claim that it is entitled to a deduction for the fiscal year ended May 31, 1945, in the amount of $ 8,901.89 representing interest on deficiencies in Federal income and excess profits tax for the fiscal year ended May 31, 1944, arising out of the respondent's disallowance of the same deduction of $ 253,774.13 for post-war reconversion expense which petitioner claimed on its Federal tax returns for the latter year. We agree. It is clear the petitioner did not accrue this interest expense on its books during the fiscal year ended May 31, 1945, and there is no evidence that it had at any time in that year recognized or conceded its liability for the deficiencies in tax and the interest which were ultimately determined by the respondent in respect to the petitioner's tax liability for the fiscal year ended May 31, 1944. For the reasons we have discussed above, we are of the opinion that petitioner is not entitled to accrue and deduct interest expense of $ 8,901.89 in the fiscal year ended May 31, 1945. Lehigh Valley Railroad Co., 12 T.C. 977, 1000.1951 U.S. Tax Ct. LEXIS 309">*330

The principal issue herein relates to the correctness of the petitioner's reported closing inventory for the fiscal year ended May 31, 1945. Petitioner purported to value its closing inventory at cost or market, whichever was lower, and reported a closing inventory of $ 1,060,289.05 as of May 31, 1945, including therein "Work in Progress" on the uncompleted vessels covered by Contracts 1847 and 1964 at a "market" value of $ 41,857 and zero, respectively, whereas the actual cost of the materials and labor expended by the petitioner on such contracts totaled $ 196,887.44 and $ 177,388.33, respectively, as of May 31, 1945.

In the notice of deficiency respondent held that the market value of such "Work in Progress" was not less than the actual cost of the materials and labor expended, and accordingly increased the petitioner's closing inventory and thereby its net income by the amount of $ 332,418.77.

16 T.C. 118">*128 The statute directly grants to the Commissioner the responsibility and the authority for determining the need and the methods to be followed for the taxpayer's use of inventories in determining income for Federal tax purposes. Section 22 (c), Internal Revenue Code. Pursuant 1951 U.S. Tax Ct. LEXIS 309">*331 to this authority, the Commissioner, in Regulations 111, section 29.22 (c)-1, has held that inventories are necessary in every business where the production, purchase, or sale of merchandise is an income-producing factor and that such inventories shall include finished goods, partially finished goods, and raw materials and supplies which have been acquired for sale or which will physicallly become a part of merchandise intended for sale.

However, the Commissioner's regulations provide that "Merchandise shall be included in the inventory only if title thereto is vested in the taxpayer." There is nothing novel about the Commissioner's requirement that a taxpayer hold title to the merchandise he seeks to inventory as this position is generally supported by the recognized authorities on accounting. See Accountant's Handbook, Second Edition, page 451, and Third Edition, pages 551-552, 558; Principles of Accounting, Third Edition, by H. A. Finney, ch. 15, page 250; Mertens, Law of Federal Income Taxation, Vol. 2, ch. 16, section 16.26, page 544, and cases cited therein.

By the express terms of Contracts 1847 and 1964, petitioner had no title to the materials supplied by the Government for1951 U.S. Tax Ct. LEXIS 309">*332 use in the construction of the harbor tugs and lighters, and for that matter during the process of construction had no title in the materials or equipment it acquired for installation in the vessels. Under these circumstances it was appropriate that the contracts provided that the petitioner was prohibited from insuring the vessels, or any of the materials or equipment used in the construction thereof. Moreover, the contract was nonassignable by the petitioner. Thus, it is clear that the petitioner held no title or interest in the vessels, materials or equipment as such, nor did it possess any product which it could sell in its own right at any stage of completion.

In our opinion, the interest of petitioner in the vessels and the materials and equipment consisted of nothing more than a contractual right to receive a fixed fee for carrying out the construction of the vessels in the manner specified in the contracts. The petitioner's contractual interest was not the equivalent of title to and ownership of finished goods, partially finished goods, or raw materials, and in our opinion for that reason did not constitute property of a nature includible in inventories as contemplated1951 U.S. Tax Ct. LEXIS 309">*333 by the Commissioner in his Regulations, and the accounting authorities in their discussions of accepted inventory practices.

Moreover, it was not until the petitioner concluded that it would probably incur losses upon completion of Contracts 1847 and 1964 in 16 T.C. 118">*129 the following taxable year that it undertook to anticipate such losses by inventorying its "work and progress" under the contracts at a "market" figure which was $ 332,418.77 less than the actual costs.

Petitioner entered into both contracts shortly after the beginning of the fiscal year ended May 31, 1945, and during that year completed three of the ten lighters covered by Contract 1964. In its Federal tax returns, petitioner for that year included in its gross income $ 122,025 representing the contract price of the three completed lighters, and in its costs the sum of $ 160,709.29 representing the actual cost of materials and labor expended in the construction of the three lighters completed and delivered during that year. Under the terms of the contract, petitioner was entitled to receive partial payments aggregating $ 119,619 and $ 58,492.50 on account of the five tugs and the seven lighters, respectively, which1951 U.S. Tax Ct. LEXIS 309">*334 were not completed during the fiscal year ended May 31, 1945. However, these partial payments were not included by petitioner in its gross income for that year but were recorded as "customer deposits" on petitioner's books and treated as deferred income on its tax returns.

It may well be that had the petitioner chosen to report its income from these contracts on the so-called percentage of completion basis and had discovered that the costs incurred in connection with the contracts were running ahead of receipts, it could have accrued and deducted the loss reflected thereby as of the close of its taxable year. However, petitioner did not choose to employ the percentage of completion basis. Instead, it appears from the petitioner's method of handling the income and costs attributable to the three lighters completed in the fiscal year 1944 and the testimony of its accountant that petitioner elected to defer its income and costs until the various units covered by the contracts were completed and delivered, at which time it would take into income the contract price of the completed unit and include in its costs the portion of the total contract costs allocable to the completed unit.

1951 U.S. Tax Ct. LEXIS 309">*335 The sole purpose of petitioner's including the materials and labor supplied under Contracts 1847 and 1964 in its closing inventory for the fiscal year 1945 at a nominal "market" value rather than cost was to record during the fiscal year ending May 31, 1945, the loss it expected to incur on the contracts in the following taxable year. Recognition of the device employed by the petitioner would be clearly violative of the long established rule that the revenue laws only permit the deduction of realized losses and not anticipated losses. Weiss v. Wiener, 279 U.S. 333">279 U.S. 333; Lucas v. American Code Co., 280 U.S. 445">280 U.S. 445. This rule applies with equal effect to those taxpayers properly employing inventories. Ewing Thomas Converting Co. v. McCaughn, 43 Fed. (2d) 503, certiorari denied, 282 U.S. 897">282 U.S. 897; Adams-Roth Baking Co., 8 B. T. A. 458; Higginbotham-Bailey-Logan Co., 8 B. T. A. 566.

16 T.C. 118">*130 Therefore, we conclude that the Commissioner did not err in determining that there should be restored to the petitioner's1951 U.S. Tax Ct. LEXIS 309">*336 income for the fiscal year ended May 31, 1945, the sum of $ 332,418.77, representing the petitioner's write-off in that year of unrealized losses which it expected to incur in connection with Contracts 1847 and 1964 in the following taxable year. Various adjustments which the parties have agreed to will be given effect under Rule 50.

Decision will be entered under Rule 50.