Nehi Beverage Co. v. Comm'r of Internal Revenue

• Decision Date: 17 May 1951
• Docket Number: Docket No. 20515.
• Citation: 16 T.C. 1114
• Parties: NEHI BEVERAGE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

16 T.C. 1114

NEHI BEVERAGE COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 20515.

Tax Court of the United States.

Promulgated May 17, 1951.

Trent G. Anderson, Jr., Esq., for the petitioner.

L. C. Aarons, Esq., for the respondent.

During the taxable year 1946 petitioner transferred $17,271.42 from its deposit liability account to its miscellaneous income account. This sum represented deposits received from customers on containers used in petitioner's business, which containers had been fully depreciated. Held, section 112(f), Internal Revenue Code, relating to recognition of gain or loss on involuntary conversions, does not apply and the gain resulting from the transfer must be recognized. Held further, the gain realized is ordinary income and not capital gain under section 117(j), Internal Revenue Code.

This case involves income tax deficiencies of $6,324.97 and $1,276.04 for the taxable years ending February 29, 1944, and February 28, 1946, respectively. Respondent's determination that there are deficiencies of $62.68 and $352.35 in declared value excess-profits tax and excess profits tax, respectively, for the taxable year ending February 28, 1945, is not in dispute.

The principal issue is whether a 1946 item of $17,271.42 is income, and if so, should it be treated as ordinary income, as determined by respondent, or as capital gain, as contended by petitioner. Respondent's treatment of the disputed item as ordinary income denied to petitioner a part of its claimed excess profits credit carry-back form 1946 to 1944, which in turn affected petitioner's 1944 tax liability. Petitioner's claim for a refund of part of its 1944 taxes, based upon respondent's alleged erroneous treatment of this 1946 income item, was denied by respondent in the statutory notice of deficiency herein.

The facts were partially stipulated.

FINDINGS OF FACT.

Petitioner is a California corporation which succeeded to the business of Nehi Bottling Company of South Gate, California, on or about June 30, 1936. At all times since that date it has been conducting a business of bottling and distributing soft drink beverages.

At all times material to the issue herein petitioner's books of account were maintained and its income, declared value excess-profits, and excess profits tax returns were prepared and filed on the accrual basis. Petitioner's Federal tax returns for the taxable years ended February 29, 1944, and February 28, 1945 and 1946, were filed with the collector of internal revenue for the sixth district of California at Los Angeles.

In the conduct of its business of bottling and distributing the said beverages, it is necessary that petitioner have bottles to contain beverages and wooden cases in which to distribute the bottles. All of the cases and bottles used in petitioner's business have for many years past, and presently have, printed or stamped thereon the words ‘Property of Nehi Bottling Company‘ or ‘Property of Nehi Beverage Company.‘ Said bottles and containers are not sold by petitioner but are released from possession of the petitioner and petitioner's agents only upon payment of deposits therefor. Such deposits vary in amount, depending on the type of bottle or container, but are uniformly less than the cost of the bottles and cases. The deposits are paid by the retail vendor to petitioner's salesmen at the time such retail vendor makes his purchase of beverages from petitioner.

Petitioner's sales are effected primarily through retail stores and petitioner's salesmen distribute the beverage in the bottles and cases to said retail stores. Such business is done in the vicinity of Los Angeles. Sales tickets are made out at the time of delivery, indicating the price of the beverage, the amount of deposit on the bottles and cases, and the amount of credits for bottles and cases returned by the retail vendor.

At the time of reordering by any retail vendor, or at any time, upon the return of bottles and cases, a refund is made of the deposit in the same amount as the original payment by the retail vendor to petitioner for bottles and cases actually returned.

By letter dated February 4, 1941, from the internal revenue agent in charge, Los Angeles, California, the petitioner was advised as follows with respect to the income tax treatment of loss on bottles:

Loss on Bottles.

That the Revenue Agent's determination that the loss due to the use of bottles, in excess of deposits received thereon, be returned through depreciation allowances, rather than inventory losses, be approved.

The internal revenue agent in charge, in computing said depreciation, based his computation upon the cost of all bottles and cases on hand and outstanding without reduction on account of deposits received. Thereafter, the petitioner did not take bottles and containers into inventory, but depreciated them on the basis of a 4-year useful life. All bottles and cases of petitioner, including those outstanding in the hands of customers, are accordingly written off as fully used at the end of 4 years after purchase. The write-off so accomplished is made on the basis of an inventory on bottles taken in the petitionerS fiscal year ended February 28, 1939, which sum has been brought forward to date by adding yearly purchases of bottles and containers as made. Such yearly purchase of bottles and containers is not deducted as an expense item, but the cost thereof is recovered by depreciation.

The petitioner has taken the deposits on bottles and cases so received by its salesmen and credited them to a liability account denominated ‘container deposits returnable.‘ Refunds of deposits on returned bottles and cases are payable from said account on demand. As refund payments of such deposits back to the retail vendor are made, they are entered as reductions of said account ‘container deposits returnable.‘

No entries have been made to said liability account ‘container deposits returnable‘ indicating any depreciation reserve or depreciation allowed.

In its taxable years ended February 29, 1940, and February 28, 1941, 1942, 1946, and 1947, petitioner made a determination that there was a surplus of deposit in the liability account ‘container deposits returnable‘ as compared to the number of bottles then in the hands of customers. In each of said years, petitioner determined to reduce said deposit liability account so that said account would, in the petitioner's opinion, more clearly reflect the actual number of bottles and cases then outstanding in the hands of customers or users.

In the taxable year ended February 28, 1946, petitioner determined that the said deposit liability account was overstated in the sum of $17,271.42, and in such year it reduced the amount of the deposit liability account accordingly and transferred an equivalent amount to an income account of petitioner entitled ‘miscellaneous non-operating income.‘

The following table shows petitioner's purchase of containers, the depreciation allowed, the annual increase or decrease in its net deposit account, the cumulative total thereof, the amount of net deposits taken into income, and the balance in the net deposit account for the fiscal years February 18, 1941, to February 28, 1947, inclusive:

+------+
                ¦¦¦¦¦¦¦¦
                +------+
                

 Containers  Net deposits
                

Taxable              Depreciation Annual       Cumulative Taken into Balance of
                period    Purchased  allowed      increase     total      income     account
                ended                             (decrease)
                2-28-41   $47,928.76 $58,017.60   $8,758.26    $81,429.03 $26,764.46 $52,500.00
                2-28-42   57,224.73  58,310.77    4,706.17     86,135.20  4,706.17   52,500.00
                2-28-43   22,052.30  50,378.03    (5,567.71)   80,567.49             46,932.29
                2-29-44   43,495.52  43,277.27    40,176.87    120,744.36            87,109.16
                2-28-45   60,378.91  43,443.74    22,222.44    142,966.80            109,331.60
                2-28-46   52,663.10  46,957.06    (2,384.61)   140,582.19 17,271.42  89,675.57
                2-28-47   123,491.90 56,056.20    84,410.48    224,992.67 14,253.72  159,832.33
                

Authorization for this transfer of funds from a liability account to an income account (from its deposit liability account to its miscellaneous non-operating income account) is contained in the minutes of a special meeting of petitioner's board of directors on December 31, 1945, which, after reciting the results of a 1945 survey of containers in dealers hands, provided in part as follows:

It therefore appears that some of the containers will never be returned and this Company will in all probability never have to return the amount in excess of $100,800.00 to its customers as a return of their deposits, hence the Corporation's financial statements would be somewhat unjustly misstated (sic), therefore it is resolved that the accounting officers of the Company be, and they are hereby authorized to forfeit to miscellaneous income, any deposits in excess of the amount of $100,800.00, which are on the books at December 31, 1945.

No part of the $17,271.42 credited to petitioner's miscellaneous non-operating income account was earmarked for the purchase of containers. Such sum was commingled with other funds of the petitioner used for corporate purposes generally.

The failure of retail dealers to return all of petitioner's containers and redeem their deposits thereon was due to various and sundry reasons, including breakage, use of the container for other purposes, and the indifference of the consumers. The non-return of some of its containers is a normal and accepted risk incident to the conduct of petitioner's business.

At all times material hereto petitioner's containers were depreciated upon their cost basis and a useful life of 4 years. No containers were depreciated upon a substituted basis as provided in sections 113(a)(9), 113(b)(2), and 114(a), Internal Revenue Code.

The schedule of capital gains and losses attached to petitioner's income tax return for the taxable...