Kekaha Sugar Co. v. Burnet

• Decision Date: 04 May 1931
• Docket Number: No. 5098.,5098.
• Parties: KEKAHA SUGAR CO., Limited, v. BURNET, Commissioner of Internal Revenue.
• Court: U.S. Court of Appeals — District of Columbia Circuit

50 F.2d 322 (1931)

KEKAHA SUGAR CO., Limited, v. BURNET, Commissioner of Internal Revenue.

No. 5098.

Court of Appeals of District of Columbia.

May 4, 1931.

W. W. Spalding, of Washington, D. C., for appellant.

G. A. Youngquist, Asst. Atty. Gen., and Sewall Key, John MacC. Hudson, C. M. Charest, and S. S. Faulkner, all of Washington, D. C., for appellee.

Before MARTIN, Chief Justice, and ROBB, VAN ORSDEL, HITZ, and GRONER, Associate Justices.

GRONER, Associate Justice.

This is an appeal from a decision of the Board of Tax Appeals holding petitioner liable for a deficiency of income excess profits taxes for 1920 in the amount of $51,475.23.

A brief statement of the facts is necessary. Petitioner is, and has been for more than thirty years, a planter and manufacturer of sugar, with a plantation and factory on one of the islands of the Hawaiian group. Its plantation is owned in fee by the territory of Hawaii, as successor of the kingdom of Hawaii. Up until May 31, 1920, it occupied its land as sublessee of one Knudsen and his assigns, and paid its rentals in percentages from 2½ to 9 per cent. of the sugar produced from cane grown on the leased land. In actual practice, it paid the agreed percentages in dollars and cents. In its findings of fact, the Board of Tax Appeals says: "The petitioner, with the approval of the Commissioner of Internal Revenue, has for many years kept its accounts and made its federal income-tax returns on the so-called `crop basis,' as permitted by the Treasury Regulations. * * *" In the Hawaiian Islands, a crop of sugar cane is planted in the spring of one year, brought under cultivation in the fall of the following year, and harvested and manufactured into commercial sugar in the third year. During each calendar year, work is being performed on three separate crops — the crop that is being harvested, the crop under cultivation which was planted the prior year, and the crop that is then being planted which will be harvested two years thereafter. The crop basis of accounting is in general use on the sugar plantations of the islands, and, under that system, a crop is treated as a venture, and an account kept for each crop. The expenses of the crop from the preparation of the soil to the manufacture of the cane into sugar is charged to the crop account, and all receipts from the crop are credited to the crop account. When the crop is disposed of, it is then determined whether a profit was realized or a loss sustained.

In 1918, petitioner paid as rental $114,159.58, representing the market value of the sugar which the lessor was entitled to receive from the crop of that year. It charged one-third of that amount to the 1918 crop, one-third to the 1919 crop, and one-third to the 1920 crop, and, in its return for 1920, deducted the amount of the payment allocated to the 1920 crop, and it is this deduction which the Commissioner refused to allow, and the correctness of this is the first question for our decision.

The Board sustained the Commissioner, saying: "In 1918 it paid $114,159.58 as the rental for that year. One-third of this was charged on its books to the 1920 crop and deducted in computing 1920 income. Petitioner contends that, since the plantation was used during 1918 for the cultivation of three crops this represented a rental for all of the land and that on the crop system of accounting it may properly allocate one-third of this rental to each of the three crops. The respondent (Commissioner), on the other hand, contends that such a rental payment is unlike other expenses of producing the crop and may not be allocated over three crop years, that the lease provides for a payment in kind which must necessarily be taken from the crop harvested, and that the rental may only be deducted as a part of the cost of such crop. We are of the opinion that the respondent is correct in his contention. The proof of this may be seen if we look at the situation in which the petitioner would have found itself had it not been able to secure the renewal of its leases beyond 1920. In such a situation, following the basis on which the 1918 rental was apportioned, the rental paid in 1919 would have been apportioned one-half for the crop of that year and one-half for the crop of 1920 and the rental paid for 1920 would all have been apportioned to the 1920 crop, for the petitioner would not have cultivated any 1921 or 1922 crops and could therefore not have charged any part of the rent for 1920 to such crops. The result would be that the 1920 crop would be charged as rental with one-third of the rent paid in 1918, one-half of the rent paid in 1919 and all of the rent paid in 1920. Such a situation would obviously work a distortion of income."

And, in the argument before us, the Commissioner insists, first, that the expenditure so made in 1918, which we understand to mean the rental paid in that year, had no relation to the 1920 crop; second, that to allow one-third of it as a deduction in 1920 would effect a distortion of income for that year; and, third, that in any event it was the payment of a general expense not identified with the crop or crops of any year or years.

We have given the subject careful consideration, and are unable to agree with the Commissioner in any of these contentions. Section 212 of the Revenue Act of 1918 (40 Stat. 1057, 1064) provides: "(b) The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income."

And section 234 (a) (1) provides that there may be a deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year * * * including rentals or other payments required to be made as a condition to the continued use or possession of property. * * *"

And Treasury Regulations 45, article 38, provides: "* * * If a farmer is engaged in producing crops which take more than a year from the time of planting to the time of gathering and disposing, the income therefrom may be computed upon the crop basis; but in any (all) such cases the entire cost of producing the crop must be taken as a deduction in the year in which the gross income from the crop is realized."

It is conceded that petitioner's method or accounting for rentals paid, namely, the allocation of such rentals proportionately to the three crop years, was regularly employed in its books of account, and that its treatment of this expense had been consistent throughout the many years of its operations, and also that this basis of accounting is in general use on sugar plantations throughout the island, and that, in the determination by the Commissioner of petitioner's tax liability for the years prior to 1920, no attempt was made to treat the entire rental paid in any year...