Lenox Clothes Shops v. Com'r of Internal Revenue

• Decision Date: 01 December 1943
• Docket Number: No. 9353.,9353.
• Citation: 139 F.2d 56
• Parties: LENOX CLOTHES SHOPS, Inc., v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Sixth Circuit

139 F.2d 56 (1943)

LENOX CLOTHES SHOPS, Inc., v. COMMISSIONER OF INTERNAL REVENUE.

No. 9353.

Circuit Court of Appeals, Sixth Circuit.

December 1, 1943.

Bernard Buchholz, of Detroit, Mich. (Max H. Field, of Detroit, Mich., on the brief), for petitioner.

Newton K. Fox, of Washington, D. C. (Samuel O. Clark, Jr., Sewall Key, Samuel H. Levy, and William A. Clineburg, all of Washington, D. C., on the brief), for respondent.

Before ALLEN, HAMILTON, and MARTIN, Circuit Judges.

HAMILTON, Circuit Judge.

The corporate petitioner operates a retail clothing store at Detroit, Michigan. A portion of its sales are for cash and a portion on the installment plan, or conditional sales contracts. Petitioner, in its income tax return for the calendar year 1936, in answer to a question on the tax form, stated that it valued its inventories at cost. For the calendar year ending December 31, 1937, petitioner, in making its income tax return, reduced its closing inventory $6,741.31 below cost, which was a flat reduction of fifteen percent. On December 31, 1937, petitioner credited on its books to its president, C. R. Murphy, the sum of $4,500 which it claimed was unpaid salary. It had paid Murphy during the year $1,500. On March 1, 1938, petitioner gave Murphy a promissory note of $4,500 and credited accounts payable $4,500 and debited notes payable $4,500. On July 1, 1938, petitioner delivered to Murphy $4,500 par value of its stock in settlement of this note. Murphy reported the $4,500 in his individual income tax return for the calendar year 1937. Respondent disallowed the reduction in inventory as a loss on the ground it was prohibited under Section 22(c) of the Revenue Act of 1936, 26 U.S.C.A. Int.Rev.Code § 22(c). He disallowed the salary accrual of $4,500 as a deduction on the ground that the entry on petitioner's books was tentative and that it was not an allowable deduction within the purview of Regulations 94, Article 22(a)-3, and also that Murphy was taxpayer's controlling stockholder and that as the salary was not paid within two and one-half months after the close of the tax year, the deduction was prohibited under Section 24 (a) of the Revenue Act of 1936, as amended by Section 301(a) of the Revenue Act of 1937, 26 U.S.C.A. Int.Rev.Code § 24(a). The Board of Tax Appeals (now the United States Tax Court) sustained the Commissioner, rejecting the inventory writedown on the ground that petitioner had elected to value its inventories at cost and that the salary credit was an unallowable deduction because petitioner had failed to prove that the services were rendered at a stipulated price as required under Regulation 94, Article 22(a)-3.

Section 22(c) of the Revenue Act of 1936, c. 690, 49 Stat. 1648, Internal Revenue Code, 26 U.S.C.A. § 22(c) provides that whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe, conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income. Pursuant to statutory authority, the Treasury Department promulgated regulations that taxpayers were given the option to adopt the basis of either (a) cost or (b) cost or market, whichever is lower, for their 1920 inventories. The basis adopted for that or any subsequent year is controlling and a change can be made only if permission is secured from the Commissioner (Treasury Regulations 94).

The requirement that the method of valuing inventory assets be consistent is basic. It is clear that in order to reflect true income there must be consistency in the method from year to year. The closing inventory at the end of one year is the opening inventory for the succeeding year and if a taxpayer is on one method at the beginning of the year and closes with another method, it would be a coincidence merely, if his true income is reflected.

Petitioner admits it used cost in valuing its inventory at the end of the tax year 1936, but it argues that cost at that time was lower than market and that it used market December 31, 1937, but insists that as of that date market was lower than cost and that the facts must be viewed as though it had followed the method of cost or market "whichever is lower." The statute provides for the selection of a method of inventory valuation and, whether or not petitioner made a choice by its answer to the interrogatory on its income tax return, it is clear that it did make a selection by the method it in fact adopted in valuing its inventory at the close of 1936 and the conclusion is inescapable that under the statute, petitioner is bound by its own selection. Mother Lode Coalition Mines Co. v. Helvering, Commissioner, 317 U.S. 222, 226, 63 S.Ct. 179, 87 L.Ed. ___. Aside from the question of petitioner's irrevocable selection of a method its petition must fail for another reason. The taxing statute relating to inventories gives a broad discretion to the Commissioner to determine the proper method of valuation and also the application of the method. The burden rests on the taxpayer to prove that the Commissioner's action was arbitrary or an abuse of discretion. Lucas v. Kansas City Structural Steel Co., 281 U.S. 264, 271, 50 S.Ct. 263, 74 L. Ed. 848; Louisville Cooperage Co. v. Commissioner, 6 Cir., 47 F.2d 599. Petitioner has failed to carry this burden.

Respondent insists that the accrued salary deduction should be disallowed because not actually paid within two and one-half months after the close of the taxable year as required under Section 24(c) (1) of the Revenue Act of 1936, as amended by Section 301(a) of the Revenue Act of 1937, Internal Revenue Code, 26 U.S.C.A. § 24(c) (1). As we view the record, this question is not before us. Before Section 24(c) (1) is applicable, the credit must have been made to the owners of more than fifty percent of the taxpayer's voting stock.

The Board of Tax Appeals stated there was no evidence in the record showing how much of the stock of the petitioner, if any, Murphy or his family owned, and that because of this lack of evidence, it did not rest its decision disallowing the salary deduction on the ground that the sum claimed had not been paid within two and one-half months after the taxable year.

The proceedings here foreclose us from deciding the facts no matter how clearly they may be disclosed by the record. General Utilities & Operating Co. v. Helvering, 296 U.S. 200, 207, 56 S.Ct. 185, 80 L.Ed. 154; Hormel v. Helvering, 312 U.S. 552, 560, 61 S.Ct. 719, 85 L.Ed. 1037; Commissioner v. Goulder, 6 Cir., 123 F.2d 686. The Board rests its decision solely on the ground that petitioner had not established the essential facts from which an allowable deduction could be determined. Burnet v. Houston, 283 U.S. 223, 227, 51 S.Ct. 413, 75 L.Ed. 991; Reinecke v. Spalding, 280 U.S. 227, 50 S.Ct. 96, 74 L.Ed. 385; Wilcox v. Commissioner, 6 Cir., 119 F.2d 899.

Section 23(a) (1) of the Revenue Act of 1936, Internal Revenue Code, 26 U.S.C.A. § 23(a) (1), provides that in computing net income there shall be allowed as deductions all ordinary and necessary expenses paid or incurred in carrying on any trade or business, including "a reasonable allowance for salaries or other compensation for personal services actually rendered." An identical provision has been in all Revenue Acts since the Act of 1918, the interpretation of which has led to three concrete rules for determining salary deductions: (1) Is the payment in fact salary or other compensation; (2) Have personal services been actually rendered, and (3) Is the...