Hamilton Indus., Inc. v. Comm'r of Internal Revenue
| Decision Date | 30 July 1991 |
| Docket Number | Docket No. 24006-88. |
| Citation | 97 T.C. No. 9,97 T.C. 120 |
| Parties | HAMILTON INDUSTRIES, INC., SUCCESSOR OF MAYLINE COMPANY, INC. AND SUBSIDIARY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
P purchased the assets of M and T in separate transactions, assigning a portion of the purchase price to inventory acquired from M and T. The value assigned to the purchased inventory was less than the value assigned to it by the targets under the first-in, first-out (FIFO) convention. Such assigned value was used as the base year cost for P's inventory under P's dollar value last-in, first-out (LIFO) method of inventory accounting. HELD, R's determination that inventory purchased in the acquisitions of M and T should be separated from raw materials purchased or goods produced subsequent to such acquisitions constituted a change in method of accounting to which section 481 applied. HELD FURTHER, finished inventory acquired in the purchase of M and T was includable in the same natural business unit pool as raw materials purchased or inventory produced by P subsequent to such acquisitions. UFE, Inc. v. Commissioner, 92 T.C. 1314 (1989), followed. HELD FURTHER, inventory acquired from M and T constituted items separate from raw materials purchased or inventory produced after such acquisitions.
P used the accrual acceptance method of accounting for long-term contracts. P determined inventory costs attributable to such contracts using LIFO inventory costs for the year income attributable to such contracts was taken into account. HELD, R's determination that P used the long-term contract method to account for its long-term contracts was erroneous. HELD FURTHER, R's determination that inventory allocable to long-term contracts constituted separate items in P's LIFO inventory pool was arbitrary.
P claimed depreciation deductions on its consolidated return with respect to property acquired by a subsidiary not in existence for the full tax year of the consolidated group. HELD, R properly disallowed a portion of the depreciation deduction claimed by the subsidiary. Leslie J. Schneider and Patrick J. Smith, for the petitioner.
Wilton A. Baker and Dianne I. Crosby, for the respondent.
Respondent determined the following deficiencies in petitioner's Federal income tax:
+---------------------------+
¦TYE June 30 ¦Deficiency ¦
+--------------+------------¦
¦1977 ¦$31,210 ¦
+--------------+------------¦
¦1980 ¦755,228 ¦
+--------------+------------¦
¦1981 ¦1,952,926 ¦
+--------------+------------¦
¦1982 ¦1,464,788 ¦
+--------------+------------¦
¦1983 ¦197,751 ¦
+--------------+------------¦
¦1984 ¦129,846 ¦
+---------------------------+
After concessions, the issues remaining for decision are: (1) Whether respondent's determination that inventory acquired as part of petitioner's purchases of other businesses should be treated as pools or items separate from raw materials purchased or inventory manufactured subsequent to such acquisitions constituted a change in petitioner's method of accounting for inventories; (2) whether respondent abused his discretion in making the foregoing determination; (3) whether petitioner used the completed contract method of accounting for long-term contracts; (4) whether petitioner's income was clearly reflected where it offset income from a long-term contract with LIFO inventory costs calculated in the year that it recognized income from such long-term contract; (5) whether respondent properly disallowed certain depreciation deductions claimed by petitioner.
Some of the facts have been stipulated for trial pursuant to Rule 91. 1 The stipulations and accompanying exhibits are incorporated in this Opinion by reference irrespective of any restatement below.
Petitioner is a corporation with its principal place of business in Des Plaines, Illinois. Prior to December 26, 1986, petitioner was a subsidiary of Mayline Company, Inc. (Mayline), and became the successor in interest of Mayline as of December 26, 1986. Mayline used an accrual method of accounting for tax purposes. For taxable years ending in 1975 and 1976, Mayline used a fiscal year ending April 30. During the taxable years in issue, Mayline's annual accounting period for tax purposes ended on June 30.
Mayline was incorporated on March 12, 1975, but did not engage in business prior to May 1, 1975. On March 25, 1975, Mayline entered into an agreement to purchase substantially all of the assets, including all of the inventory, of Mayline Company, Inc. (old Mayline). The price paid for old Mayline's assets was $3,000,000, plus assumption of old Mayline's liabilities. The agreement specifically allocated the purchase price among the assets acquired, excepting inventory. The residue of the purchase price was allocated to inventory. On the date that the sale was closed, April 29, 1975, old Mayline valued its inventory at $2,034,680.48 under the first-in, first-out (FIFO) convention.
Mayline allocated $79,028.32 of the purchase price to the inventory purchased from old Mayline, which was further allocated among each item of inventory in proportion to its relative FIFO value in old Mayline's inventory at April 29, 1975. After the purchase, Mayline continued old Mayline's business of manufacturing drafting equipment and related furniture and accessories. Acquisition of old Mayline's inventory was necessary to continue such business. The products produced after the acquisition were identical to those produced by old Mayline prior to the sale. In maintaining its inventory records, Mayline made no distinction between inventory purchased in the acquisition of the assets of old Mayline and inventory subsequently purchased or produced. After the acquisition, Mayline also purchased drafting equipment and furniture as inventory for resale.
On its return for its taxable year ended April 30, 1975, Mayline elected to use the dollar value last-in, first-out (LIFO) inventory accounting method for its entire inventory. Mayline also elected to include its entire inventory in a single natural business unit (NBU) pool and to use the double extension method in computing the LIFO value of its NBU pool. On April 30, 1975, Mayline's inventory consisted only of the inventory it had purchased from old Mayline. Mayline possessed an itemized listing of the inventory acquired from old Mayline. In subsequent years, Mayline treated the amount of the purchase price it had allocated to old Mayline's inventory as the base-year cost for inventoriable items it purchased and manufactured.
Hamilton Industries, Inc. (Hamilton), was incorporated May 12, 1982, as a wholly owned subsidiary of Mayline, but did not engage in business prior to June 28, 1982. Hamilton used the accrual method of accounting to compute taxable income. On May 19, 1982, Hamilton entered into an agreement to purchase substantially all of the assets, including all of the inventory, of the Two Rivers Division of the Hamilton Division of American Hospital Supply Corporation (Two Rivers). The purchase price equalled $31,300,000, plus assumption of certain liabilities. After the acquisition, Hamilton continued Two Rivers' business of manufacturing laboratory and hospital case goods and furniture. Purchase of Two Rivers' inventory was necessary to continue such business.
Two Rivers used the LIFO convention to value its inventory, and, as of June 28, 1982, the closing date of the sale, it valued such inventory at $6,550,262. The inventory also was valued under the FIFO convention at $16,566,320. The amount of the purchase price allocated to the inventory equalled its LIFO value in Two Rivers' hands, $6,550,262, which was further allocated among the items in inventory on the basis of their relative value as compared to the total inventory, determined using the FIFO convention. In keeping its inventory records, petitioner did not distinguish between inventory purchased from Two Rivers as part of the acquisition and inventory purchased or produced subsequently.
On its initial tax return, filed for the taxable year ended June 30, 1982, Hamilton elected to use the dollar value LIFO method of valuing its inventory. Hamilton also elected to include its entire inventory in a single NBU pool, and to use the double extension method in computing the LIFO value of its NBU pool. On June 30, 1982, Hamilton's inventory primarily consisted of inventory purchased from Two Rivers. For taxable year ended June 30, 1982, Hamilton considered the cost of its earliest inventory acquisitions during the year to be the FIFO inventory values shown on the books of Two Rivers on June 28, 1982. In subsequent tax years, Hamilton treated the amount of the purchase price it had allocated to the inventory purchased from Two Rivers as the base year cost for such inventoriable items.
Generally, petitioner's business was limited to the manufacture of goods for its customers; occasionally, however, it also contracted to install on customers' premises office furnishings petitioner manufactured. On average, such installation contracts required up to 24 months to complete, although a small number required more time. Petitioner included payments with respect to such contracts in gross income 90 days after installation was completed, when the customer was deemed to have accepted the work. Petitioner accumulated the cost of producing furniture and cabinetry pursuant to such contracts in its LIFO inventories. Petitioner allocated costs to inventory under the “full absorption” costing rules of section 1.471-11, Income Tax Regs. On its initial return, covering the taxable year ended June 30, 1982, Hamilton elected to account for income from long-term contracts under the “accrual acceptance” method. Hamilton's audited financial statements for fiscal years ending in 1983 and 1984 stated that it used the accrual...
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