American Can Co. v. Bowers

• Decision Date: 04 November 1929
• Docket Number: No. 11-14.,11-14.
• Citation: 35 F.2d 832
• Parties: AMERICAN CAN CO. v. BOWERS, Collector of Internal Revenue, and three other cases.
• Court: U.S. Court of Appeals — Second Circuit

35 F.2d 832 (1929)

AMERICAN CAN CO. v. BOWERS, Collector of Internal Revenue, and three other cases.

Nos. 11-14.

Circuit Court of Appeals, Second Circuit.

November 4, 1929.

Simpson, Thacher & Bartlett, of New York City (Philip G. Bartlett, Graham Sumner, and A. McCalman, all of New York City, of counsel), for appellants.

Charles H. Tuttle, U. S. Atty., of New York City, and Thomas J. Crawford, Sp. Asst. to Atty. Gen. (Edward Feldman, Asst. U. S. Atty., of New York City, of counsel), for appellee.

Before MANTON, L. HAND, and SWAN, Circuit Judges.

MANTON, Circuit Judge.

The four appellants in these actions seek recovery of additional income and excess profits taxes paid under duress for the year 1917 (39 Stat. 756; 40 Stat. 300). During the year 1917, the appellants kept their books and filed returns, as permitted by section 13(d) of the Revenue Act of 1916 (39 Stat. 771), showing a consolidated net income of $17,944,400.46 which included $60,010.50 as dividends. This income was increased, when audit was made by the Commissioner, and upon a reaudit was again increased, so as to show a net income of $24,949,668.51, including the dividends.

Appellants are engaged in manufacturing and selling tin cans and other containers. It was necessary to have on hand constantly tin plate for their manufacture. In 1916, they paid $3.60 per box for tin plate. There was a sharp rise in price in the latter part of 1916 and it reached $7.50 in March, 1917. Appellants charged their customers at the rate of $7 per box, taking advantage of the market increase, and it is established that this increase in price of $3.40 per box was added to their usual manufacturing profit. They did not report this additional profit in their return so made. By journal entry, on January 31, 1917, the American Can Company wrote up as its inventory of raw materials and goods in process by crediting its "inventory write-up" account by $5,403,406.70 and debiting the cost ledger the same amount. By journal entry it increased its inventory of finished products by crediting inventory write-up and debiting various finished products accounts by the same amount. Thus, by these entries, they brought the tin plate inventories from the actual cost of $3.60 per box up to $7. The total inventory write-up of this company amounted to $6,514,479.04, part of which is shown in the profits of the company, but $4,722,500 is claimed to represent the write-up of "normal stocks," and went into a special account set up for the first time in January, 1917, called "Inventory Constant." This account was set up by means of a journal entry whereby inventory write-up was debited and the new "inventory constant" account credited with this sum. Similar bookkeeping entries were made in the books of the other appellants, in all involving the sum of $5,671,500. Thus the book cost of goods was increased and the income understated.

The appellants reported the higher costs rather than the lower costs in their returns. This inflation of cost was disallowed by the Commissioner. It was proved that the appellants took their closing entries in their entirety, inclusive of normal stocks, for the purpose of profit and loss estimates, at cost or market, whichever were lower, and they were unable to establish that they had on hand at the end of 1917 any of the tin plate which had cost them $3.60 per box. The book elimination of this additional income was due to the write-up and the entries in other accounts. The "constant" accounts were liability accounts, and were constituted reserve accounts to take care of inventory losses in future years. The treatment of the "constant" accounts is similar to the treatment in balance sheets of reserves for depreciation.

Appellants claim that this item does not constitute a part of their true consolidated net income as reported on an accrual basis. They contend that the same is not taxable income under the statute. Section 13(d) of the act 1916 (39 Stat. 771), provides: "A corporation * * * keeping accounts upon any basis other than that of actual receipts and disbursements, unless such other basis does not clearly reflect its income, may, subject to regulations made by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, make its return upon the basis upon which its accounts are kept, in which case the tax shall be computed upon its income as so returned."

This act, as amended in part by the 1917 act (40 Stat. 300), was intended by Congress to extend the income tax as far as possible to all species of income. Heiner v. Colonial Trust Co., 275 U. S. 232, 48 S. Ct. 65, 72 L. Ed. 256; Irwin v. Gavit, 268 U. S. 161, 45 S. Ct. 475, 69 L. Ed. 897. The section deals with a system of accounting where the taxpayer's accounts are kept on any basis other than actual receipts and disbursements. The income is presumed to have been received, even though not actually received, and expenses incurred, even though not actually disbursed. The cash basis of accounting had theretofore been dealt with by Congress, which referred to the actual receipts and disbursements.

This new basis or system of accounting refers to other than a cash basis. It is based upon the fundamental principle upon which the corporate accounts are kept. If, when arriving at income, the bookkeeping system contemplates that receipts and disbursements are deemed received and disbursed when the income accrued and the liabilities are incurred, then the basis of accounting is that of an accrual system, as pointed out by the Supreme Court in United States v. Anderson, 269 U. S. 422, 46 S. Ct. 131, 70 L. Ed. 347 in construing section 13. Difficulties were involved in the preparation of income accounts on a strict basis of receipts and disbursements. Because of business complexity, when considering the acts of 1909 and 1913 (36 Stat. 11; 38 Stat. 114), it became necessary to authorize, by departmental regulation, a method of preparing returns not in terms provided by those statutes. This gave rise to the purpose of the act of 1916. Sections 12(a) and 13(d), 39 Stat. 767, 771. It was to enable taxpayers to keep their books, and make their returns according to scientific accounting principles, by charging against income earned during the taxable year, the expenses incurred in and properly attributable to the process of earning the income during that period, and to require the tax return to be made on that basis, if the taxpayer failed or was unable to make the return on a strictly cash received and disbursed basis.

The courts have held that, in keeping accounts on an accrual basis, referred to in the statute, it was intended that there may be charged, against income earned during the taxable period, the expenses incurred in and properly attributable to the process of earning income during the period. United States v. Anderson, supra; Aluminum Castings Co. v. Routzahn (C. C. A.) 31 F.(2d) 669. Necessarily, net income, for tax purposes, is a conception of the income tax statute, and the amount arrived at is ascertained by deducting from the gross amount of income received by the taxpayer from all sources the specified deductions allowed to it by statute. For corporate purposes only, it may well be, on the other hand, that net income may be arrived at by the deduction of entries and accounts which are not permissible for purposes of taxation. Weiss v. Weiner, 279 U. S. 333, 49 S. Ct. 337, 73 L. Ed. 720.

The appellee argues that "basis," as used in the statute, includes every process and every method used in determining any factor which affected the amount of the net income stated in the return, and requires the consideration of every figure in the return which relates to the net income. Having made their returns, in accordance with such a basis, appellants say there is no occasion for reconciliation of the net profits as per their books with the federal tax return of 1917. They say that the tax "shall be computed upon the income as so returned," and in construing the basis as used in section 13 (d) that the Commissioner must compute the tax on the income as returned without correction. But the section provides for the computation of the tax upon the income "as so returned," upon the basis upon which the accounts are kept, instead of income computed upon the basis of actual receipts and disbursements. The requirement of section 10, as amended by Act Oct. 3, 1917, § 1206 (40 Stat. 333), was intended to reflect the true income of the taxpayer. If it does, the return may stand as filed upon the accrual basis. If not, the Commissioner may still, treating the return as on an accrual basis, make corrections on such basis as he would if it were filed upon a cash basis.

Here the Commissioner made no change as to the accrual system of accounting. He disallowed the inflation of cost for the tin plate — a sum which did not truly represent its cost — and declined to permit the increase by means of bookkeeping entries. In so doing, he did not change the method of bookkeeping; his act was not an inconsistent treatment of any item on the returns; it was merely a correction of an item incorrectly stated on the same...