Diamond a Cattle Co. v. Comm'r of Internal Revenue

• Decision Date: 09 October 1953
• Docket Number: Docket No. 7352.
• Citation: 21 T.C. 1
• Parties: The Diamond A Cattle Co., Petitioner v. Commissioner of Internal Revenue, Respondent
• Court: U.S. Tax Court

21 T.C. 1

The Diamond A Cattle Co., Petitioner

v.Commissioner of Internal Revenue, Respondent

Docket No. 7352.

Tax Court of the United States.

Promulgated October 9, 1953.

M. T. Woods, Esq., and W. Clayton Carpenter, Esq., for the petitioner

Marvin E. Hagen, Esq., and Gene W. Reardon, Esq., for the respondent.

1. ACCOUNTING— ACCRUAL— YEAR.— The petitioner used an accrual method of accounting, as determined by the Commissioner, and deductions for interest and taxes and income from sales must be taken into account in the years accrued.

2. ORDINARY INCOME v. CAPITAL GAIN— BREEDING HERD.— Unbred heifers and ewe lambs were not part of breeding herds and gain on their sale was ordinary income.

3. EXCESS PROFITS TAX— NET OPERATING LOSS CARRY-BACK— LIQUIDATING CORPORATION— SECTION 23(s) AND 122.— See below.

4. EXCESS PROFITS TAX— CREDIT CARRY-BACK-LIQUIDATING CORPORATION— SECTION 710(c)(3).— Where a corporate taxpayer's assets are transferred to its sole stockholder in a liquidating distribution after incurring substantial operating expenses but before its usual selling period in which it would realize almost all of its income, no net operating loss carry-back and no unused excess profits credit carry-back is allowed.

The Commissioner determined deficiencies as follows:

+---------------------------------------------+
                ¦    ¦          ¦Declared value¦              ¦
                +----+----------+--------------+--------------¦
                ¦Year¦Income tax¦excess-profits¦Excess profits¦
                +----+----------+--------------+--------------¦
                ¦    ¦          ¦tax           ¦tax           ¦
                +----+----------+--------------+--------------¦
                ¦    ¦          ¦              ¦              ¦
                +----+----------+--------------+--------------¦
                ¦1940¦$11,691.62¦$4,956.61     ¦$5,833.84     ¦
                +----+----------+--------------+--------------¦
                ¦1941¦24,280.75 ¦              ¦53,764.13     ¦
                +----+----------+--------------+--------------¦
                ¦1942¦5,306.78  ¦1,479.18      ¦68,882.30     ¦
                +----+----------+--------------+--------------¦
                ¦1943¦7,513.35  ¦              ¦28,377.65     ¦
                +---------------------------------------------+
                

The issues for decision are:

1. Was interest paid in the taxable years 1940, 1941, and 1942 not deductible because it accrued in prior years?

2. Did the profit from a sale of sheep accrue in 1941 and did the profit from a sale of cattle accrue in 1943?

3. Were the excess profits tax for 1943 and on interest item, paid in 1944, deductible in 1944 in computing a 1944 net operating loss carry-back, or did they accrue in 1943?

4. Were unbred heifers and ewe lambs capital assets so that gains from their sales were capital gains?

5. Did the petitioner sustain a net operating loss for 1945 which can be carried back and deducted form 1943 income?

6. Can an unused excess profits tax credit be carried back from 1945 to 1943?

7. Should $42,947 be excluded from income for 1943 and $114,128 for 1944 because the Commissioner allegedly required those amounts, representing the normal growth and natural increase of animals, to be eliminated from the opening inventory for 1945?

FINDINGS OF FACT.

The petitioner was incorporated many years ago but changed to its present name in 1940. Its returns for the taxable years were filed with the collector of internal revenue for the district of Colorado.

It engaged extensively in the livestock business, breeding, grazing, and selling Hereford cattle, sheep, and some horses. The number of cattle in its closing inventories during the taxable years averaged about 25,880. Its farming operations were negligible and incidental to its livestock business. Substantially all of its income was from the production and sale of livestock. Sales are not made usually until late in the year.

The petitioner kept its books and records upon an accrual method of accounting in which it inventoried its livestock upon the unit-livestock-price method, except for a few purchased animals which were inventoried at cost. The income which it reported each year from the production and sale of livestock was computed by adding the cost of livestock purchased during the year to the opening inventory, subtracting the closing inventory, and deducting the remainder from gross receipts from sales of the year.

The Commissioner, in determining the deficiencies, disallowed deductions and made adjustments for interest and sales profits which he explained as follows:

(1940) It is held that since the accrual method of reporting net income has been adopted by you only interest applicable to the current year is deductible from income of the current year. You claimed as a deduction the total interest paid during the year, $68,637.93. Of this amount, $29,183.34 should have been accrued in years prior to 1940 and for that reason is disallowed as a deduction herein.

(1941) Adjustment is made here to include in income the profit ($52,801.85) realized on the sale of sheep in 1941 to J. P. White, et al., but not recorded in your books until 1942. See contra adjustment * * * year 1942.

You claimed as a deduction the total interest paid during the year, $115,612.71. Of this amount, $79,287.25 should have been accrued in years prior to 1941 and for that reason is disallowed as a deduction herein. See further explanation * * * year 1940.

(1942) You claimed as a deduction an amount of $117,261.60 representing interest paid during the year. Of this amount, $104,373.32 should have been accrued in years prior to 1942 and for that reason is disallowed as a deduction herein. See further explanation * * * year 1940.

This adjustment of $52,801.85 is made to exclude from income for the year 1942 the profit on the sale of sheep to J. P. White, et al. See contra adjustment * * * year 1941.

The petitioner agreed in 1941 to sell most of its sheep to J. P. White, acting for himself and several associates, at 10 cents per pound for ewe lambs and at specified prices per head for the other types of animals. Thereafter, the animals were counted, the ewe lambs were weighted, the total purchase price of $175,642.10 was determined, the animals were branded with the brands of the purchasers, and they were grazing on land owned by or under the control of the purchasers, all before the close of 1941. The purchasers were willing and able to make the full cash payment and give the notes agreed upon representing the purchase price in 1941 but delayed, at the request of the petitioner, until early in January 1942 when they gave a check and notes in payment for the sheep. The sale resulted in a profit of $52,801.85 to the petitioner which accrued as income to it in 1941. Included in the sale were 1,462 ewe lambs which were sold for $10,201.10. The record does not show that ewe lambs were a part of the breeding herd, that they were capital assets, or that they had been held for more than 6 months prior to their sale.

The petitioner reported as income for 1944 the profit from the sale of some cattle. The Commissioner, in determining the deficiency for 1943, did not include that profit in 1943 income and the evidence does not show that it was accruable as income in 1943.

The petitioner, in 1944, paid $193,011.05 of its excess profits tax for 1943 and interest of $3,200 on notes. Both of those items accrued in 1943 and the Commissioner, in determining the deficiency, allowed the interest deduction for 1943 because it accrued in that year.

Heifers of the petitioner were bred for the first time after they became 2-year-olds. Age changes were recognized as of April 1 of each year. The cattle were rounded up each spring and each fall. All weaned calves were branded when first rounded up and were first accounted for in the next inventory. Heifers inventoried as yearlings at the end of each year were held with the purpose of using some of the better ones as replacements in the breeding herd after they became 2-year-olds and with the purpose of selling as many, beginning with the poorer ones, as might seem desirable in the following year in the light of then existing conditions, including grass conditions, losses from the breeding herd, financial needs of the petitioner, market conditions, and others. About 1,286 one-year-old heifers were sold, on an average, and closing inventories of one-year-old heifers averaged about 1,840, during the taxable years. The unbred heifers sold in 1942 and 1943 were not a part of the breeding herd and were not capital assets.

Leon E. Williams, hereafter called Williams, a certified public accountant experienced in tax matters, purchased all of the stock of the petitioner on July 27, 1944, and took over the management of its business. He caused the petitioner to distribute its assets and liabilities to him as a liquidating dividend in cancellation of all but qualifying shares of its stock on August 15, 1945. Thereafter, Williams operated the business as a sole proprietorship and the petitioner ceased to engage in business but has continued to exist in order to conclude its affairs.

The notice of deficiency in this proceeding is dated December 21, 1944. Williams, on behalf of the petitioner, entered into correspondence with the Commissioner on February 28, 1945, for permission to change the petitioner's method of reporting its income to the cash receipts and disbursements method. Permission was first granted, subject to stated conditions, and later withdrawn.

The petitioner reported a net operating loss of $337,671.38 for 1945 subtracting $32,346.50 as cost of total livestock sales of $878.50 and deducting $312,570.41. The Commissioner determined a deficiency for that year but the parties thereafter agreed that there was no deficiency in income tax or declared-value excess profits tax for 1945, leaving open the question of a net operating loss carry-back.

The petitioner did not have for 1945 a net operating loss within the meaning of section 122 or an unused excess profits tax credit within the meaning of section 710(c)(3).

All facts stipulated or admitted in the...