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Carlisle Tire & Rubber Co. v. Commissioner of Internal Revenue.

decided: May 28, 1948.


Author: O'connell

Before MCLAUGHLIN and O'CONNELL, Circuit Judges, and RODNEY, District Judge.

O'CONNELL, Circuit Judge.

The Commissioner has asserted and the Tax Court has found a deficiency in petitioner's excess profits tax return for the year 1943. The instant appeal raises three questions: (1) Whether petitioner, having entered into a written compromise agreement with the Commissioner concerning indebtedness on excise taxes due the government, was, pursuant to the terms of such agreement, entitled to deduct, as an expense, interest accrued but not paid on the original amount of said excise taxes; (2) whether the Tax Court erred in excluding evidence which petitioner offered, to the effect that certain employees in the Philadelphia office of the Collector of Internal Revenue construed the compromise agreement to require such payment of interest; and (3) whether petitioner could treat as invested capital the difference between the amount which petitioner owed a non-stockholder creditor and that which petitioner actually paid in settlement of the creditor's claim. All three questions were resolved against petitioner by the Tax Court.

Petitioner, a manufacturer of tubes for automobile tires, owed excise taxes in the sum of $257,555.05. Unable to pay this liability, petitioner, on July 15, 1941, prepared on a government form a written "Offer in Compromise," to which was attached a financial statement indicating liabilities well in excess of the fair market value of the assets of petitioner. By letter dated April 14, 1942, the Commissioner accepted the offer as made. The agreement provided that petitioner, in discharge of its excise tax liability, was to pay 20% of its "annual net income for the next five years payable annually as determined for federal income tax purposes but after federal income taxes due for each of the five years have been deducted." It was further provided that accrued interest would be payable (a) in the event that the property of petitioner was sold during the term of the agreement, and the amount realized beyond mortgage indebtedness permitted full payment of the tax originally due, or (b) if the 20% payments in less than five years attained the total amount of the tax due the government. These provisions, attached as a rider to, and incorporated by reference in a paragraph of, the "Offer in Compromise" form, apparently supplanted the following language which was deleted from the printed form: "together with interest at the rate of 6% per annum on all deferred payments from the date this offer is received by the collector until the respective payments are made in full."

The next-to-last paragraph of the Commissioner's letter states that petitioner agrees to the waiver of refunds and all other conditions contained in the "Offer in Compromise," "except the payment of interest on the payments made under the terms of this agreement."

Twenty per cent of the "annual net income" of petitioner, as defined in the compromise agreement, for the years 1941 to 1945 inclusive, is $61,747.65. Petitioner has paid $43,662.21 to the government, the remainder being deposited in escrow in a Carlisle, Pennsylvania, bank during the pending litigation.

Keeping its records on the accrual basis, petitioner neither accrued on its books and records nor claimed on its 1941, 1942, or 1943 tax returns any sum alleged to represent interest due on the excise tax which had been the subject of the compromise agreement. Petitioner now takes the position that the settlement agreement does require the payment of interest; that both petitioner and the Commissioner so interpreted the agreement; and that partial payments made in accordance with the agreement must first be credited to interest.

We agree with the Tax Court that this compromise agreement eliminates the interpretation for which petitioner here contends. The striking of the printed language on the compromise form, the paragraph of the Commissioner's letter excepting the payment of interest, the setting forth of two contingencies requiring the payment of interest, plus the nature of the agreement itself, are consistent only with the interprettation enunciated in the memorandum opinion of the Tax Court. The pattern of the settlement was to permit petitioner to continue in business by requiring the payment of only a specified percentage of its net income for five years to be allocated to the excise tax, and to assure that in no event would petitioner pay a tax greater than that which would have been due had no settlement intervened. We believe that the reasoning of the Tax Court is sound and requires no further elaboration.

Moreover, the contention of petitioner that the settlement was treated by the parties as contemplating the payment of interest in some situation other than the two express contingencies, neither of which occurred, is not supported by the record before us. Petitioner for a period of three years failed to take any action indicating that petitioner so interpreted the agreement. The offer of proof which the Tax Court excluded could at best have shown that certain employees in the Collector's office agreed with the interpretation now advanced by petitioner. Such testimony, besides encountering inhibitive rules of evidence, still lacked the necessary link of showing the opinions of those employees to represent that of the Commissioner, who had made the agreement. Exclusion of the proffered testimony did not constitute reversible error.

The final question for our determination arises out of the settlement of a debt which petitioner owed to a New York importing and brokerage company for rubber purchases, rubber wash sales, and interest. By a cash payment of $50,000 in 1932, petitioner was released of its debt totalling $550,598.10. This transaction was recorded on the books of petitioner by crediting $47,658.42 to "Profits and Loss", since that sum represented purchases from the importer-broker in 1932, and $452,939.68 to "Surplus". Petitioner did not treat this forgiveness of indebtedness for income tax purposes as realization of income. The Commissioner excluded the $452,939.68 from equity invested capital, of which action the Tax Court approved on the strength of Liberty Mirror Works v. Commissioner, 1944 3 T.C. 1018.

"Equity invested capital" is defined in Section 718 of the Internal Revenue Code, 26 U.S.C.A. Int. Rev. Code, ยง 718.*fn1 Petitioner urges that sound accounting practice calls for crediting the forgiven debt to paid-in surplus, that such credit is a true "paid-in surplus", and that no distinction should be made between contributions by stockholders and those by non-stockholders such as the importer-broker.

The question presented by petitioner is not without difficulty. The record does not disclose how the importer-broker creditor, a concern in financial difficulties, treated the transaction. At the hearing, little if any testimony was adduced to indicate what would be considered established accounting practice for such a transaction; and neither the language of the statute and applicable Treasury regulation nor the legislative history are greatly illuminating in ascertaining whether "equity invested capital" includes a debt forgiveness by a non-stockholder creditor. We have found no appellate decision on this precise issue. If, however, accounting practice is to be used as our guide, as urged by petitioner, we must turn to the Tax Court, particularly in the absence of other controlling judicial interpretations, as the body whose determination is to be accorded great weight in such matters. Dobson v. Commissioner, 1943, 320 U.S. 489, 64 S. Ct. 239, 88 L. Ed. 248. Since the decision in the Liberty Mirror case, supra, the Tax Court consistently has taken a position construing purported additions to equity invested capital to exclude such transactions as that here involved. See Doylestown and Easton Motor Coach Co. v. Commissioner, 9 T.C. 846; McKay Products Corp. v. Commissioner, 9 T.C. 1082; Brown Shoe Co., Inc., v. Commissioner, 10 T.C. 291; and Walgreen, Inc., v. Commissioner, 10 T.C. ___. Cf. Montgomery's Federal Taxes - Corporations and Partnerships, 1946-47, Vol. II, page 369. On the facts of the case before us, consequently, we accept the conclusion that the $452,939.68, for excess profits tax purposes, could not be considered equity invested capital.

For the reasons stated, the decision of the Tax Court ...

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