Las Cruces Oil Co. v. Comm'r of Internal Revenue
| Decision Date | 09 September 1974 |
| Docket Number | Docket No. 859-73. |
| Parties | LAS CRUCES OIL COMPANY, INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Towner Leeper and Jesus Samaniego, for the petitioner.
James N. Mullen, for the respondent.
The assets of two partnerships engaged in selling petroleum and related products were transferred to petitioner in a transaction meeting the requirements of sec. 351, I.R.C. 1954. The final returns of the partnerships erroneously omitted portions of their closing inventories. Held, under sec. 362(a)(1), I.R.C. 1954, petitioner is entitled to use as its basis for its opening inventory the actual amounts of inventory on hand, unadjusted for the errors in the partnerships' final returns.
Respondent determined deficiencies and additions to tax with respect to petitioner's Federal income taxes for the fiscal years ending June 30, 1969, and June 30, 1970, in the following amounts:
+-------------------------------------+
¦ ¦ ¦Addition to tax ¦
+------+------------+-----------------¦
¦ ¦ ¦(sec. 6653(a), ¦
+------+------------+-----------------¦
¦Year ¦Deficiency ¦I.R.C. 1954) ¦
+------+------------+-----------------¦
¦ ¦ ¦ ¦
+------+------------+-----------------¦
¦1969 ¦$12,199.06 ¦$609.95 ¦
+------+------------+-----------------¦
¦1970 ¦5,652.17 ¦282.61 ¦
+-------------------------------------+
The only issue is whether, under section 362(a)(1),1 a corporation to which assets were transferred tax-free under section 351 takes as its basis for its opening inventory the erroneous total of the closing inventories shown on its predecessors' final returns or the actual amount of the predecessors' inventory on hand at the time of the transfer.
Petitioner Las Cruces Oil Co., Inc. (hereinafter sometimes referred to as petitioner), is a New Mexico corporation and, when the petition was filed, had its principal place of business in Bayard, N. Mex. Petitioner sells petroleum and petroleum-related products as well as automotive accessories such as tires and parts. In maintaining its books and records and computing its income taxes for the years in issue, petitioner employed the accrual method of accounting.
On July 1, 1968, the assets of two partnerships, Las Cruces Oil Co. and Neudecker Bros. Shamrock (hereinafter the partnerships or transferors), were transferred to petitioner in exchange for its stock in a transaction meeting the requirements of section 351(a).2 The partnerships had used the accrual method of accounting in maintaining their records and filing their partnership information returns.3
At the end of the taxable period January 1, 1968, through June 30, 1968, the transferors' inventory sheets reflected inventory on hand, valued at cost, in the amount of $14,419,26. In computing the cost of goods sold reported on the final information returns of the two partnership returns filed for that period, the partnerships reported a total closing inventory of only $7,679.54. The discrepancy between this figure and the inventory actually on hand was due to the partnerships' failure to count in closing inventory certain gas and diesel fuel, in the amount of $6,739.72, stored underground. Respondent's brief refers to this error as an ‘omission,‘ and there is no evidence suggesting the partnerships' understatement was not inadvertent.
Petitioner computed its income tax liabilities for its 1969 and 1970 taxable years using the actual amount of the inventory transferred ($14,419.26) to it by the partnerships rather than the closing inventory figure erroneously reported by its predecessors on their final returns ($7,679.54). On audit, respondent determined that petitioner must use the lower figure as its opening inventory, and petitioner here contends that determination was erroneous.
Section 362(a)(1)4 provides that, in the case of a transaction to which section 351 applies, the transferee corporation's basis of the transferred property shall be the same as it would be in the hands of the transferor. Respondent urges that, since the transferor partnerships' closing inventories in this case were shown on their final returns as $7,679.54, that figure, albeit erroneous, must be used by petitioner as its opening inventory. Respondent argues that petitioner should not be allowed to use its actual opening inventory figure because, if it does, the $6,739.72 will be recovered twice (i. e., the partnerships will have understated their closing inventories by that amount, thereby reducing their taxable income, and petitioner will have reduced its taxable income by including such amount in its opening inventory).
We hold for petitioner.
Significantly, section 362(a)(1) refers to the transferor's ‘basis' in the transferred assets.5 In providing for the carryover of the transferor's basis in a section 351 transaction, section 362(a) does not state that the transferee corporation's basis shall be some figure used in the transferor's final return or in computing the transferor's taxable income for a stated period. Rather, the section refers to a carryover basis ‘the same as it would be in the hands of the transferor.’ Accordingly, the issue, in substance, is what was the basis of the inventory in the hands of the partnerships. The answer depends upon whether the understatement of the closing inventory in the partnerships' returns should have been corrected for the year in which it was made or may be carried forward and perpetuated as a compensatory adjustment to the opening inventory of petitioner for the succeeding year in which petitioner held the assets.
Ordinarily, of course, a taxpayer's opening inventory is the same as his closing inventory for the immediately preceding year. However, where a taxpayer has made a mistake in computing closing inventory for the prior year, his basis is not adjusted for the mistake. Corrections should be made for the year of the mistake, and the proper opening inventory should be used for the succeeding year.6 The correctness of this principle was assumed in Commissioner v. Gooch Co., 320 U.S. 418 (1943), even though the adjustment of the closing inventory for the prior year resulted in a barred overpayment for that year. Further, section 1013, dealing specifically with the basis of property included in inventory, provides that if property should have been included in closing inventory for the prior year, its basis shall be the ‘last inventory value thereof.'7
We think respondent errs in arguing that the predecessor partnerships' omission from closing inventory of the gas and diesel fuel stored underground has the effect of reducing the basis for the inventory on hand at the time of the transfer to petitioner. This omission did not reflect a consistent application of the predecessors' method of accounting.8 Rather, it was the result of an inadvertent error in the use of their established accounting method. The error must be correct through an adjustment for the year in which it was made rather than through an income-distorting or compensatory adjustment in petitioner's first taxable year. See Wood-Mosaic Co. v, United States, 160 F.Supp. 636, 641 (W.D. Ky. 1958), affirmed per curiam 272 F.2d 944 (C.A. 6, 1959), certiorari denied 363 U.S. 803 (1960); Lundborg & Co. v. White, 3 F.Supp. 610 (D. Mass. 1933).
In cases involving other types of property, the courts have held that a taxpayer's basis in property is not reduced or eliminated by erroneous deductions in an earlier year.9 In Kenosha Auto Transport Corporation, 28 T.C. 421, 424-425 (1957), the taxpayer was allowed a deduction for cargo loss and damage in 1948 even though part of its basis was improperly deducted in prior years as anticipated losses. The Court said ( 28 T.C. at 425) that this conclusion was ‘reasonable and necessary if we are to recognize the principle of the annual accounting period and the purpose of statutes of limitations.’
In Crosley Corporation v. United States, 229 F.2d 376 (C.A. 6, 1956), the taxpayer deducted in 1939 the costs of tooling for the production of radios and refrigerators. Subsequently, the taxpayer claimed that such costs should have been capitalized and deducted in part in 1940 and 1941. Sustaining the taxpayer's claim, the court said (229 F.2d at 379):
Any such item incorrectly reported as a matter of law can later, subject to applicable statutes of limitation, be corrected by the Commissioner or the taxpayers. * * * Such corrections can be made in later years, notwithstanding the fact that offsetting corrections in earlier returns may be barred by the Statute of Limitations.
See also United States v. Albertson Co., 219 F.2d 920, 923 (C.A. 9, 1955); cf. Manhattan Building Co., 27 T.C. 1032, 1043 (1957).
Respondent's ‘double-deduction’ argument was recently answered by this Court in B. C. Cook & Sons, Inc., 59 T.C. 516 (1972), where, as in the instant case, the deduction in the prior year was erroneous. In that case, one of the taxpayer's employees had embezzled funds and had so manipulated inventory purchases as to give the taxpayer current deductions for the amounts embezzled. Upon discovery of the embezzlements, the taxpayer claimed a loss deduction. The Court pointed out that the prohibition against double deductions evolved in the context of cases where the taxpayer correctly treated an item in an earlier barred year, receiving a tax benefit therefrom, and then sought to obtain a similar tax benefit in a later year; Allowing the deduction, the Court added (59 T.C. at 521):
If we were to apply the doctrine prohibiting double deductions in a situation such as this, where the petitioner's action in earlier years was erroneous, we would turn that doctrine into a sword to pierce the shield of repose provided by the statute of limitations, and there would appear to be little need for the mitigation provisions...
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