D. Loveman & Son Export Corp. v. Comm'r of Internal Revenue, Docket Nos. 71711

• Decision Date: 05 August 1960
• Docket Number: Docket Nos. 71711,71712.
• Citation: 34 T.C. 776
• Parties: D. LOVEMAN & SON EXPORT CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.D. LOVEMAN & SON, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

34 T.C. 776

D. LOVEMAN & SON EXPORT CORPORATION, PETITIONER,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.D. LOVEMAN & SON, INC., PETITIONER,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket Nos. 71711

71712.

Tax Court of the United States.

Filed August 5, 1960.

[34 T.C. 777]

Richard Katcher, Esq., and Sheldon J. Gitelman, Esq., for the petitioners.

William O. Allen, Esq., for the respondent.

1. During the tax years in which the issue is presently in controversy, petitioners, which used inventories priced at cost or market whichever is lower, valued their steel in accordance with the posted prices of the major steel-producing mills. However, by reason of governmental controls and shortages occasioned by the Korean conflict, petitioners were not able to purchase steel from the major mills. Instead, steel was obtained primarily from one of a number of smaller mills at premium prices (considerably higher than the prices of the major mills), and, under OPS regulations, such steel could in turn be resold at a 50 per cent markup. Held, the Commissioner properly disapproved the use of the major mill prices in pricing petitioners' inventories; petitioners' ‘market’ was the one in which they actually purchased their steel and not the theoretical market of the major mills that was not open to them.

2. Held, except for inventory dates of December 31, 1953, and August 31, 1954, the Commissioner's adjustment of inventory values for second quality and scrap steel approved. As to inventories on December 31, 1953, and August 31, 1954, held, values determined by petitioners were too low, but proper values should be not less than prevailing major mill prices for first quality steel, since that market was open to petitioners at those times rather than to petitioners' higher cost in a different market.

3. Held: ‘Freight-in’ is not deductible as a current expense; it must be treated as part of cost of acquiring merchandise. Amount of ‘freight-in’ determined.

4. Held, there was in fact no obligation to pay interest by one petitioner to the other on an open account during the fiscal year ended August 31, 1954; accordingly, a deduction for interest claimed by the debtor for that year was properly disallowed.

5. Held, the contribution of one of the petitioners towards the paving of a dead end street adjoining its warehouse was a capital item for which it is entitled to depreciation.

Respondent determined deficiencies in petitioners' income taxes as follows:

+------------------------------------+
                ¦Docket No.¦Year ended ¦Deficiency¦
                +----------+--------------+----------¦
                ¦ ¦(Aug. 31, 1952¦$1,574.87 ¦
                +----------+--------------+----------¦
                ¦71711 ¦(Aug. 31, 1953¦23,488.21 ¦
                +----------+--------------+----------¦
                ¦ ¦(Aug. 31, 1954¦1,685.92 ¦
                +----------+--------------+----------¦
                ¦ ¦ ¦ ¦
                +----------+--------------+----------¦
                ¦ ¦ ¦ ¦
                +----------+--------------+----------¦
                ¦ ¦(Dec. 31, 1951¦131,583.06¦
                +----------+--------------+----------¦
                ¦71712 ¦(Dec. 31, 1952¦25,558.25 ¦
                +----------+--------------+----------¦
                ¦ ¦(Dec. 31, 1953¦None ¦
                +------------------------------------+
                

In Docket No. 71711, the deficiency for the fiscal year ended August 31, 1952, resulted from respondent's disallowance of a net operating loss carryback from the fiscal year ended August 31, 1954. In Docket No. 71712, respondent did not determine a deficiency for the taxable year ended December 31, 1953, but he did make certain inventory adjustments for that year which affected the amount of a net operating loss carried back to the taxable year ended December 31, 1952.

The questions presented are:

(1) Did petitioner D. Loveman & Son, Inc., improperly determine the market value of its inventories of first quality steel as of December 31, 1951, and December 31, 1952? Did petitioner D. Loveman & Son Export Corporation improperly determine the market value of its inventory of first quality steel as of August 31, 1953?

(2) Did petitioner D. Loveman & Son, Inc., improperly determine the market value of its inventories of alleged second quality and scrap steel as of December 31, 1952, and December 31, 1953? Did petitioner D. Loveman & Son Export Corporation improperly determine the market value of its inventory of alleged second quality and scrap steel as of August 31, 1953?

(3) Is petitioner D. Loveman & Son, Inc., entitled to treat as a current expense, rather than as a part of cost of goods, the amount of its ‘freight-in’ for 1951, 1952, 1953? If not, what is the amount of ‘freight-in’ applicable to its closing inventories in those years?

(4) Is petitioner D. Loveman & Son Export Corporation entitled to deduct interest accrued by it with respect to an indebtedness to D. Loveman & Son, Inc.?

(5) Is petitioner D. Loveman & Son Export Corporation entitled to deduct its share of paving a road adjacent to its warehouse or, in the alternative, is it entitled to deduct any amount representing depreciation thereon?

[34 T.C. 778]

FINDINGS OF FACT.

Petitioners D. Loveman & Son, Inc. (hereinafter referred to as Domestic), and D. Loveman & Son Export Corporation (hereinafter referred to as Export) are Ohio corporations, each having its principal office in Bedford Heights, Ohio, and each employing an accrual method of accounting.

Domestic reports its income on a calendar year basis whereas Export uses a fiscal year ending August 31. Domestic filed its corporate income and excess profits tax return for 1951, and an amended return for 1951 dated July 16, 1952, with the collector of internal revenue for the eighteenth district of Ohio; it filed its returns for 1952 and 1953 with the district director of internal revenue at Cleveland, Ohio.

Export filed its income and excess profits tax return for the fiscal year ended August 31, 1952, with the collector of internal revenue for the eighteenth district of Ohio; it filed its returns for the fiscal years ended August 31, 1953, and August 31, 1954, with the district director of internal revenue at Cleveland, Ohio.

Both Domestic and Export are engaged in the business of buying and selling steel materials and, since incorporation, each has used the lower of cost or market method in pricing its inventories. Domestic was incorporated on January 2, 1946, as the successor to a partnership formed in 1931 by David Loveman and his son, Darwin E. Loveman (hereinafter referred to as Loveman). Export was incorporated on September 8, 1947, as the result of the development of steel sales to foreign countries. During the taxable years in question, Loveman and Herbert Merlin (hereinafter referred to as Merlin) served as vice president and secretary-treasury, respectively, of both corporations. Merlin entered the steel business in 1946 when he joined Domestic.

Prior to 1951, and during the existence of its predecessor partnership, Domestic did not require and did not have a warehouse of its own, preferring whenever possible to arrange for the direct shipment of steel from producing mill to customer. Occasionally, it would store merchandise in a public warehouse. At December 31, 1950, Domestic's entire inventory consisted of two lots of steel, as follows:

+-----------------------------------------------------------------------------+
                ¦Shipment in transit on high seas, priced at cost f.o.b. Rotterdam ¦$45,846.76¦
                +------------------------------------------------------------------+----------¦
                ¦Merchandise at Weiss Steel Company, Forest Park, Illinois, priced ¦6,515.60 ¦
                ¦at cost ¦ ¦
                +------------------------------------------------------------------+----------¦
                ¦Total ¦52,362.36 ¦
                +-----------------------------------------------------------------------------+
                

On November 29, 1951, the Office of Price Stabilization promulgated Ceiling Price Regulation 98 (hereinafter referred to as C.P.R. 98) for the stated purpose of correcting the ‘chaotic’ situation in

[34 T.C. 779]

the resale market for steel products which had arisen following the outbreak of hostilities in Korea. C.P.R. 98 established resale ceiling prices for steel products on the basis of ‘uniform industry-wide resale percentage markups * * * over current material costs,‘ with allowances for ‘customary geographical differentials.’ At the same time, however, it prohibited resellers of steel from marking up the price of any steel product which was resold without first having been put through a warehousing operation. The term ‘warehousing of iron or steel products' was defined in C.P.R. 98 as—

the actual receipt and unloading of iron or steel products for sale or resale in substantially the same form as received into premises regularly maintained (not a public warehouse) and equipped with facilities for performing such operations as receiving, stocking, sorting and grading, pipe-threading, cutting, shearing, flame-cutting or burning to size and shape, and shipping and other like operations which are necessary or incidental to the resale and distribution of the particular products brought into those premises.

Domestic was not engaged in a warehousing operation within the purview of C.P.R. 98. Therefore, before the end of 1951, Domestic found it necessary to obtain, and for the first time did obtain, private warehouse facilities in Cleveland. In 1953, Domestic leased space at Export's Perkins Road warehouse in Bedford Heights, Ohio.

The Korean conflict, and the resultant shortage of steel supply in relation to demand, also impaired Domestic's ability to purchase steel from its regular sources of supply. Prior to the fall of 1951, Domestic was able to purchase most of its steel requirements from such major mill producers as Jones & Laughlin Steel Corporation, Republic Steel Corporation, and Bethlehem Steel Corporation. With the development of the steel shortage, however, Bethlehem stopped shipping steel to the Cleveland the other major producing mills refused to sell to Domestic because their production was already spoken for by virtue of allocations and priorities to other customers. Consequently, Domestic...